Founded in 1993, Check Point (NASDAQ:CHKP) is an established leader in the Cybersecurity Industry. They are the most valuable company in Israel by market capitalization and employ over 5000 people globally. Global Cybercrime is forecasted to grow at 15% per year over the next five years, reaching an eye watering $10.5 trillion annually by 2025, this is more than the cost of natural disasters! Insurance firms have also noticed claims spiking, AIG announced a spike of 150% in ransomware claims since 2018 and the CEO of Chubb calls Cybercrime the “next pandemic”. As more enterprises move their hardware based IT from on premises to the Cloud and more employees work remotely, the need for security is paramount. To combat these growing threats, the Cybersecurity market is forecasted to grow at 9.68% CAGR until 2026 reaching a market size of $211 billion.
Check Point is poised to help companies protect themselves from rising threats, while also adopting new technologies and transitioning to a cloud-based environment. Check Point has the highest margins in the industry, they are making a strong operating profit and after the recent pullback in share price, the stock is undervalued. Let’s dive into the business model, financials and my advanced valuation model, to find out the juicy details.
Check Point Software Technologies (CHKP) offers a wide portfolio of Cybersecurity products across three growing markets:
User & Access Security
The company’s flagship product (Quantum) offers real time cybersecurity protection. For Cloud Security (Cloud Guard) includes security and visibility solutions for the main cloud providers (AWS, Microsoft Azure and Google Cloud). This is especially useful for companies transitioning from a traditional on premises IT network to the Cloud.
Check Point Harmony offers a single security solution for remote users. While their Network Security segment includes a Zero Trust solution (Check Point Infinity) and a unified dashboard for companies to monitor devices. The company serves a variety of industries and business sizes which makes them a one stop shop for Cybersecurity.
One element of my investment strategy is to invest into companies which are founder led and their CEO has “skin in the game”. In this case, Check Point was founded Gil Shwed, who is still the CEO today and owns a massive 19.47% of the company, this aligns him closely with shareholders.
Gil Shwed is also an experienced veteran of the cybersecurity industry, he is considered the inventor of the modern firewall and has several patents under his name, according to the Check Point website.
Compared to many other Cybersecurity companies in the Industry, Check Point offers the highest margins, solid cash flow, profits and doesn’t make bold growth projections. The company generated $2.17 billion in revenue for FY21, up 6% from $2.06 billion in the prior year. This growth was driven by a major increase in software subscriptions, which jumped from $671 million to $755 million in 2021. For Q12022, the company also continued to produce a steady 7% growth rate on their revenue to $543 million, while subscription revenue jumped by 14% to $202 million.
Most Cybersecurity companies operate with a SaaS business model and thus have high gross margins. However, Check Point has the highest margins in the industry; Gross Margin is at 87% to 90% and it’s actually profitable with a 41% operating margin. This is a rarity relative to other competitors. For example:
Zscaler (ZS) has a slightly lower, but still fantastic Gross margin of ~77%. Other Cybersecurity companies have gross margins between 54% (Mandiant) to 63% (Cisco) and 69% for Palo Alto Networks.
A few percentage points higher on the gross margin is nice, but Check Point really stands out with its high operating margin (41%) which is larger than all companies I have analyzed. As you can see from the chart below, the company with the closest margin is Cisco which has “just” a 27% margin. While other pure SaaS players such as Zscaler and Mandiant are operating at a loss of -31% and -46% respectively. In all fairness to these companies the loss is attributable to their high R&D spend and huge investments into sales and marketing, hence their much higher growth rates. However, given the current climate of rising interest rates, it is still nice to see a traditional company producing solid profits, while also attacking a growing TAM in the Cloud transformation industry.
Check Point has one of the strongest balance sheets in the industry with $3.8 billion in cash and the majority of their current liabilities $1.6 billion simply deferred revenue. The same is true for the company’s long-term liabilities which includes $457 million in deferred revenues.
The company is also bullish on their own stock and repurchased ~2.5 million shares for approximately $325 million in Q12022.
In order to value Check Point, I’ve plugged the latest numbers into my advanced discounted cash flow model. I have estimated revenue to grow at a 6% rate per year for the next 5 years, which is in line with historic levels and very conservative given the industry tailwinds. I’ve predicted their operating margin to creep up slightly to 45% over the next four years, which again is very conservative.
In order to improve the accuracy of the valuation, I have capitalized R&D (Research and Development) expenses of approximately $292 million per year, using the spreadsheet calculator below.
Given these factors, I get a fair value of $132 per share, given the stock trades at a $122 per share right now it is ~8% undervalued with conservative revenue estimates.
Monte Carlo Simulation
To further capture the range of possible outcomes I have run a Monte Carlo simulation, which has estimated between a 5% to 12% revenue growth for the next 2 to 5 years. Given this model, I get a distribution of potential stock values between $129 and $159, which are all higher than the current stock price. The mean of these values is $143 per share, which represents a 17% upside to fair value from the current price of $122.
Values Input: 5% to 12% growth rate (ignore the decimals, this is from the spreadsheet model).
I like to value stocks both intrinsically and relative to competitors across a variety of metrics. In this case, I will use the Price to Sales [PS] ratio, Price to Earnings [PE] ratio and an EV to EBITDA multiple.
Check Point trades at the 2nd cheapest price to sales ratio (7) (purple line) well below hyper growth stocks such as Zscaler which trades at a PS ratio of 30 (orange).
Check Point also trades a low forward PE Ratio of 17 (purple line), which is also one of the lowest in the industry. Only Cisco trades cheaper with a PE ratio of 14, but they do have lower margins.
The EV to EBITDA multiple also shows the same story, with Check Point trading at one of the cheapest levels (EV to EBITDA = 13) (purple line), just above Cisco (EV to EBITDA = 9).
Check Point operates in a heavily competitive market with competitors such as Zscaler, CrowdStrike (CRWD) and many other players investing huge sums for growth. If Check Point doesn’t start investing more into growth, they may lose market share.
Declining Profits and Slow Growth
Interestingly enough the share price of Check Point is only up 14% over the past 5 years, with lots of volatility in between. Revenue has increased by ~14% but I did notice operating profit has actually declined by -2.3% since 2018. This could be a sign companies are providing competitor products more enticing or management getting complacent and not executing for growth.
Country Risk (Israel)
Check Point was founded in Israel, has over 5000 employees globally and are listed on the NASDAQ, thus I would consider them an international company. However, there still may be a slight country risk which is baked into the market price of Check Point’s stock, given the region surrounding Israel is known to be volatile.
Rising Interest Rates
Morgan Stanley expects up to 6 interest rate hikes in 2022 alone to curb inflation. This environment causes higher discount rates and lower valuation multiples for growth stocks. As Warren Buffett recently said at the Berkshire annual meeting 2022, “Inflation Swindles Everybody”. Luckily for Check Point, they are in a strong financial position and are profitable with conservative growth estimates moving forward, thus I expect this stock to outperform others in the industry moving forward.
Check Point is a tremendous company which has industry leading margins, strong profits and are operating in a growing market. The increasing number of Cyber threats and geopolitical uncertainty should offer a runway for continued expansion. The stock is currently undervalued both intrinsically and relatively and thus could be a great buying opportunity. The main risks are highlighted above, which include management’s ability and desire to execute a growth strategy similar to competitors. There are a lot of undervalued stocks in the market right now (see my other posts) so that may also impact your investment decisions.