Opportunities in Security Software

Opportunities in Security Software

With cybercrime as a growing threat in today's world, many opportunities exist for tech firms that develop software to counter these attacks. Especially in the lucrative enterprise market, there is a growing need for digital protection. Check Point Software Technologies is an industry leader in enterprise network security software. With a history of solid earnings growth, the firm also has several opportunities for expansion in its core markets. With a fair valuation, the stock looks like a stable choice.

Stock basics

Check Point, headquartered in Israel, offers a range of security software solutions, specializing in network security products, a business in which it has managed to acquire a dominant position. It also offers ZoneAlarm for consumers, as well as technical support services. With a market cap of $11.43 billion, it is a fairly large player in the industry. The stock is up nearly 21% in the last twelve months, and with a beta of 0.96, is more or less as volatile as its index.

Earnings Growth

While past performance obviously doesn't offer any guarantees, it does give some insight into the company's ability to maintain growth. Check Point has done just that. Slowly but steadily, the company increased annual EPS from $1.59 in 2007 to $3.19 in 2012, beating the consensus every year. Analysts are expecting earnings to grow by 6.8% in 2013, which is around double the industry average.

For Q2 2013, the company delivered fairly upbeat results, with revenue increasing 4% year-over-year. While the operating margin dipped a bit, net income rose by 2%. More encouragingly, the company's cash flow from operations increased a whopping 30% year-over-year to $204.7 million.

While the company's margins appear to be dipping slightly, they are still way ahead of those of the prime competitor in the network security space, Fortinet . Fortinet has a strong position in the smaller business segment, with some 70% of deals worth less than $100,000. Also, it is slightly more geographically diversified, which should allow the company to profit from growth in emerging markets.

However, Check Point's impressive gross margin of 88% trumps Fortinet's 72%, and the operating margin of 55% isn't even in the same league as Fortinet's 18%. Additionally, Fortinet recently came out with some fairly disappointing first quarter results, lowering its full-year revenue outlook by 5%. Going forward, the company expects its operating margin to dip around a percentage point in the next quarter.

Threats and Opportunities

The network security industry was recently shaken up by Cisco's acquisition of security software maker Sourcefire. According to commentators, the $2.7 billion deal was made in an attempt to strengthen its position in software, as its core business of networking hardware has been slowing and its security division is more or less flat.

Perhaps a first step toward a wave of consolidation in the security software market, it is clear that Check Point will face increasing competition from larger names in IT. Some have even speculated that Check Point may be a takeover target for Cisco, although it would be a considerably pricier one than Sourcefire. However, with Cisco's ridiculously large balance sheet, they would easily be able to fund the transaction in cash.

The good news is that Check Point is fairly well positioned for growth. The company's 'blade' architecture, a modular system that allows devices to be connected to a central security solution, offers it greater flexibility than competing software solutions. Instead of purchasing several separate products, companies can just add these modular features to their existing solution. These software blades are still showing double-digit year-over-year growth, and this is expected to continue.

Whereas Check Point is traditionally regarded as occupying the higher-end of the enterprise security software market, the introduction of its 600 Series Appliances will allow it to compete with lower-end suppliers such as Fortinet. Costing between $400 and $1200 dollars, the system is aimed at smaller businesses, while still offering a comprehensive range of solutions including Next Generation Firewall and Threat Prevention. This release netted the company a Network World Clear Choice award, beating out the competition's offerings.

Finally, the company also seems to be growing in its bread-and-butter high end security solutions. Deals of $50,000 or larger comprised 68% of total orders versus 66% a year ago. Additionally, the firm's average selling price is on the increase, which presumably means that customers are willing to pay more for top-notch security software. All this leads to a fairly optimistic outlook for the next quarter.

Valuations and Metrics

Not a particularly expensive stock, Check Point currently trades at 18.94 times trailing earnings, which is below the 23.2 industry average. For comparison, Cisco trades at 14.45 and Fortinet at 58.05. The price-to-book isn't too high either at 3.38. The return on equity of 18.68% is decent, and as mentioned before, the margins are excellent. Finally, the company has zero debt and around $1.24 billion in cash.

The Bottom Line

The growing occurrence of cybercrime has naturally led to a growing importance of security software, especially in the public sector and the corporate world. There are several companies active in this segment, but Check Point seems to have a leading position in the network security market. With several factors expected to lead to continued growth for the company, it looks like a solid bet, and moreover isn't too expensive at the moment.

The article Opportunities in Security Software originally appeared on Fool.com.

Daniel James has no position in any stocks mentioned. The Motley Fool recommends Check Point Software Technologies and Cisco Systems. The Motley Fool owns shares of Check Point Software Technologies. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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