Check Out Check Point

As mobile and cloud become more important for customers, the potential vectors of attack become increasingly serpentine, which we think could expand Check Point’s market opportunity. Check Point excels because of its large-enterprise-focused model and a broad product portfolio, yielding high renewal rates and a growing recurring revenue base. Further, we think the company’s ability to churn out new offerings allows it to meet the rapidly evolving technological needs of its client base. Check Point continues to earn exemplary marks in its threat detection rates from independent reviews. We estimate that nearly 70% of the company’s revenue is recurring, and we see switching costs from its mission-critical security offerings for sprawling enterprise clients whose demands necessitate a vendor with ubiquitous solutions like Check Point. The company’s focus on software blade subscriptions (suites of integrable software products that can be selected or deselected based on the client’s preference) sold into the enterprise allows Check Point to extract respectable pricing from clients and post outstanding gross and operating margins.

Check Point’s Infinity product represents the next iteration of its management console. We think clients are in a consolidation phase as they limit security subscriptions to a single vendor, which should benefit Check Point based on its reputation and expansive product portfolio.

Check Point is a market leader, but secular trends such as the growth in cloud computing, the Internet of Things, and artificial intelligence remain on the periphery. We see these themes as potential avenues for disruption, but because each spawns added threats to Check Point’s client base, they create additional vectors for Check Point to secure.

Robust Switching Costs Result in Narrow Moat We believe that the mountainous undertaking of deploying a large enterprise network firewall, coupled with the macro trend of cybersecurity product consolidation, benefits Check Point's relatively diverse ecosystem of available offerings and creates a robust degree of switching costs, resulting in a narrow economic moat. Typically, the rapidly evolving nature of the cybersecurity industry has made it difficult to construct a moat, particularly as malicious actors have shown a propensity to outpace the ability of security providers to detect, protect against, and respond to new malevolent threats. However, we believe Check Point is in a league of its own because of its operational reputation, the fairly high attach rate of its core firewall business, and its comprehensive suite of integrable software subscriptions. These factors yield unparalleled margins and returns on invested capital among the security vendors we cover. Check Point's many services, which include supplying firewall, endpoint, and mobile protection, among many others, become embedded in the IT infrastructure of large organizations. We believe any potential benefit of switching to a competitor would pale in comparison with the costs of implementation and training required when deploying a new solution, not to mention the risks of a potential breach allowed by technology from a less reputable vendor.

Check Point originally established itself as a pre-eminent supplier of network firewall technology. A company’s IT security teams would install a firewall to limit the access into internal IT environments. Check Point was well positioned to build share in large enterprises thanks to its long record of reliability, innovation, and an international presence. We believe firewalls benefit from a multiyear refresh life cycle. Recently, the industry has undergone a metamorphosis as network security has become increasingly complex, with organizations moving away from the data center. Software as a service, endpoint protection, mobile, and the hybrid cloud have all made the IT environments increasingly byzantine. As Check Point has built subscription-based software offerings to meet the protection needs of its customers across each of these potential penetration vectors, switching costs have become entrenched.

Check Point offers a plethora of solutions, including small and midsize and enterprise firewalls, endpoint protection, mobile security, malware protection, advanced threat protection for public, private, and mobile cloud environments. We see this as a more complete solution set than certain rivals have. We conclude that with each subsequent product or subscription a customer purchases from Check Point, the stickier the relationship becomes. Many current clients began using Check Point’s firewall product and added a software blade product as their businesses grew. Given the Internet of Things, whereupon a customer’s light, lock, or thermostat may eventually need protection at the enterprise level, we believe complexity will only increase.

We believe there is evidence of product consolidation, with clients now wanting all their applications managed in one place, by a single vendor. In the past, the cybersecurity market was characterized by companies that specialized in one niche. Today, however, for many businesses it no longer makes sense to have separate cybersecurity vendors for each area. Thus, as enterprises and small and midsize businesses consolidate under one platform, we believe Check Point will benefit as it arguably has the most comprehensive suite of subscription-based offerings. Threats to its customers can be managed under one console. Check Point anticipated this trend, as it expanded its software blade offerings to cater to a multitude of clients, allowing customers to mix and match subscriptions to fit their needs as their respective businesses scale. We believe the recently launched Infinity product cements this trend; as clients use several of Check Point’s offerings in this single console, switching costs increase.

Large and New Competitors a Concern One concern for Check Point remains the secular shift away from the data center to public cloud infrastructure vendors such as Amazon AMZN and Microsoft MSFT. While AWS and Azure provide basic security features, we believe they lack the cohesive offerings and functionality that incumbent firewall vendors like Check Point can provide, in addition to what security-conscious enterprises have historically shown they have needed. Amazon, Microsoft, and Google GOOG could conceivably build out their respective software offerings, which could be supported by their scale and marketing power as enterprises migrate to the cloud.

Newer voracious competitors such as Palo Alto Networks PANW and Fortinet FTNT have adopted an aggressive go-to-market strategy, with Palo Alto spending 50% of its revenue on sales and marketing (compared with Check Point’s 23% in 2017). These competitors have attempted to disrupt incumbents such as Check Point, Cisco CSCO, and Juniper Networks JNPR. The firewall space was disrupted by Palo Alto’s launch of its next-generation firewall, demonstrating that a competitor can take share with an innovative offering. We can’t rule out the threat of other innovative startups over time. Check Point may need to respond to this intense competition with renewed investment in sales and marketing, potentially weighing on margins. Finally, we think Check Point has been marred by execution issues with regard to relaying the breadth and depth of its product portfolio to clients and shedding its reputation as an “old world” firewall vendor.

Check Point is in exemplary financial health. It now has $4 billion in cash and marketable securities on its balance sheet. We expect the company to perennially buy back its own stock. Check Point has historically been opportunistic in its acquisitions, only buying businesses that it believed to be well below fair value or in instances where management believed it could not build the product internally. Given the cash balance and decelerating growth, we would be amenable to bolt-on acquisitions to move the company into high-growth areas.

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