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Check Point Software Has Gotten Expensive

Richard Saintvilus

NEW YORK ( TheStreet) -- Shares of enterprise security giant Check Point Software are up almost 10% over the past couple of weeks, while also having made several new 52-week highs.

I don't believe it's coincidence that investors have flocked to Check Point's stock immediately after Cisco announced its $2.7 billion deal for anti-hacking company Sourcefire , a deal that I consider to be very expensive at 12 times revenue, which assigned a 30% premium to Sourcefire.

The Street, meanwhile, wasted no time making predictions as to which would be the next company to be picked off. Looking to stay ahead of the game, analysts rushed to adjust their valuation models, immediately proclaiming how cheap other security companies were. Even Fortinet , which has struggled to post any sort of returns all year, benefited from Cisco's willingness to overspend.

I get that tech companies often trade in tandem. So if Cisco values Sourcefire at a 30% premium, logic would say that Sourcefire's peers should command something close. But it's not always an "apples to apples" comparison.

In the case of Check Point, a little more understanding is required. First, there's no denying the company still has a sizable market lead in enterprise network security. But unlike Sourcefire, which continues to grow at a 20% clip, Check Point's recent performance has shown no "fire" at all, including growth of only 4% this recent quarter.

While that was still enough to beat Street estimates, investors who have chosen to put their faith in the stock -- even with the company's lack of momentum -- are also betting that Check Point can reverse its poor showing in product revenue, which declined again recently by 2%. This has been a recurring trend. Unlike Cisco, which has no problem spending to grow, I can't say that Check Point's management has shown this sale level of commitment.

Management has shown it cares more about the company's books, which are excellent by the way, than posting the growth that Wall Street craves. I say this because, aside from buying Dynasec in 2011, Check Point has not been as aggressive in expanding its enterprise footprint. Nor has management put forth enough efforts to seek new addressable markets.

I've said this on more than one occasion: Good cost management can only be effective for so long. Contrary to popular opinion, I don't believe that Check Point has done enough to secure or add to its current market share.

Another concern that I have is that Check Point's margins have begun to disappoint, which was noticeable again this recent quarter. Not only was gross margin for the second quarter come in flat when compared to last year, but it was also worse than the first quarter. That operating income declined 3% sequentially suggests that management is having a tough time balancing the company's growth objectives with profits.

As with Fortinet, it's starting to look as if new entrants such as Palo Alto Networks , which has posted 54% revenue growth in the recent quarter, is adding pressure to Check Point's margins. I expect that this new Cisco-Sourcefire union will continue to impact upon Check Point's bottom line.

If there's good news, it's that the enterprise security space is still pretty significant. I believe the continued adoption of mobile devices within BYOD, or bring-your-own-device, will continue to spur demand for tighter security.

The question, though, is to what extent Check Point's management will invest to capitalize on that growth. I don't believe management can sit idly and cede the market to Cisco, which has close to $50 billion to spend. In that regard, it also wouldn't surprise me if Check Point becomes the subject of an acquisition.

Given Check Point's $11.5 billion market cap, I don't think it will be slam-dunk deal. But this is where the company's strong books may make it an attractive play. I believe IBM and Oracle would make sense as acquirers. Whether a deal happens remains to be seen.

But in the meantime, I believe Check Point is an expensive stock at a P/E of 19, which presumes that growth will get back to double-digit levels. I haven't seen enough to believe that this is going to happen. I think a safer play here is Cisco.

At the time of publication, the author held no position in any of the stocks mentioned.

This article was written by an independent contributor, separate from TheStreet's regular news coverage.

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