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Check Point Software Could Be A Second-Half Rebounder

Stephen D. Simpson, CFA

It's pretty well-established that buying stocks in the summer months is a recipe for underperformance (the so-called “Sell in May and go away” effect). That's even truer for tech stocks, which makes the notion of buying underperforming Check Point Software (Nasdaq:CHKP) for a second half rebound sound a little crazy. Sometimes crazy works, though, and investors may have a real reason to keep an eye on these shares.

No Good News Yet In Q1

Check Point has had a growth problem for some time now, and that didn't get noticeably better in the first quarter. In fact, the best that can be said about Check Point's first quarter performance is that it marked the end of what has been more than a two-year period of sequential quarterly growth deceleration.

Revenue was up 3% as reported this quarter and down 12% sequentially, missing estimates by a small margin. Product revenue was okay relative to analyst estimates, though it did fall 3% and 29% respectively. While the company noted some more deal slippage in the quarter, billings improved 5% from last year and ASPs were higher due to the mix of new appliances.

While revenue growth is clearly a problem here, Check Point management deserves credit for preserving the margin structure. Gross margin actually improved on both an annual and sequential basis, with product GM up just a bit from last year and down a bit sequentially. Operating income was up 1% from the year-ago period, and though operating margin did decline (down one point from last year), it was a point better than the average sell-side estimate.

Losing Share In A Growth Market?

One of the good points about the security market is that it's an all-weather growth market – no matter how bad things get, the thinking goes, enterprises will continue to spend on security technology. To that end, a variety of independent research organizations have projected high single-digit growth for this market in 2013 (in the neighborhood of 8%).

If that's accurate, that's a problem for Check Point, as it shows that the company is losing share. One of the challenges that Check Point has been facing is a customer trade-down – customers have been buying new products from Check Point that offer similar functionality to what they previously bought, but at lower price-points. At the same time, Palo Alto (NYSE:PANW) continues to make a splash with its newer technologies and Cisco (Nasdaq:CSCO) has made security a priority in its new operating philosophy.

I'd be careful about counting out Check Point at this point. It's true that Check Point has a perception issue to address (prospective clients often think it's more expensive that it really is), and it's also true that Cisco and/or Juniper (NYSE:JNPR) could shake things up with an acquisition. But Check Point has been diligent in introducing new appliances, and new products like a Threat Emulation Software blade could improve growth trends. What's more, while Check Point's share has been moving in the wrong direction, the company still has an overall market share position well ahead of smaller rivals like Sourcefire (Nasdaq:FIRE) and Fortinet (Nasdaq:FTNT).

The Bottom Line

I've been relatively supportive on Check Point for some time now, but the stock has fallen about 14% and badly lagged both the Nasdaq composite and rivals like Cisco. During that time I've held off on buying the shares for myself largely because I wanted to see signs that the growth deceleration had bottomed out. With this quarter's performance, maybe we finally have that.

Check Point produces copious cash flow, and shares a fair bit of it with shareholders. While that may be music to value investors' ears, it doesn't often move tech stocks. For Check Point to work from here, investors need to see those product revenue and bookings numbers accelerate – the company doesn't have to beat Palo Alto or Fortinet, but it has to stop looking as though the company is going to get lapped and left in the dust.

Admittedly, my expectations for Check Point don't suggest that it will become a tech investor darling again – long-term revenue growth of roughly 5% and free cash flow growth approximately half that level don't typically lead to robust multiples in tech. That said, value is value, and I believe that Check Point shares can outperform from here if the company has in fact reached a nadir in its product revenue growth rates.

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