Despite its recent wobble, the S&P 500 is up 12.5% from its low in early June. That's made it tougher to find attractively priced stocks for the Orange Portfolio, but one company I already own in the portfolio is back at its June price and looks very attractive right now.
Check Point Software Technologies (Nasdaq: CHKP ) released very good results in July, though revenues came in just a tick below the consensus estimates. Much more important to me is that its sales of software blades were up 60% in the second quarter. That matters because most of Check Point's blade sales are subscriptions, with the cash collected up front and high renewal rates.
A quick refresher
Check Point is a leader in the network security space and it keeps the cash coming in by using a razor-and-blade model in its offerings. The company's security appliances are the razors that bring in a healthy chunk of revenues, while the blades are the software customers buy to enable different types of protection on their networks. The need for security never goes away, and that leads to a recurring stream of sales for Check Point, with additional sales growth as companies look to beef up their networks against new threats.
Last quarter this led to 9% growth in revenues and a 13% improvement in earnings per share. But deferred revenues were up 17%, and that tells me while companies might be delaying purchases of new equipment, they're still renewing their subscriptions and adding new ones.
On its earnings call, Check Point spelled out just how well renewals of software blades are going, even those that are bundled with the initial purchase of an appliance. According to Check Point, it's normal to see 10% renewals on software products that are bundled with appliances, but they're seeing renewals rates in the 30% to 50% range. I expect this trend will continue as smartphones and tablets become an increasing part of the computing landscape, and Check Point's offerings gives companies the ability to incrementally add to their security and guard against more frequent and remote access to sensitive data.
A great value
Check Point has a great business model and it's very attractively priced. In the last 12 months, Check Point's operating cash flow was a very healthy $789 million on sales of $1.3 billion. With a current market cap of $10 billion, that puts the shares at just 12.6 times operating cash flow. That's a bargain for a company with the ability to grow operating earnings at 12% to 16% a year.
Check Point also has a little more $3.1 billion in cash and investments and no debt. So while there are some risks I'll get into next, the company has the financial strength to weather a recession.
What could go wrong
Check Point is a very strong business, but there are two risks I'll be watching closely. The first is the economic crisis in Europe. Check Point is a global business with 56% of its revenues coming from outside the U.S. -- and most of that from Europe. I believe Europe's economic crisis will worsen before it gets better. Companies need to keep their networks up to date and so far sales in Europe have remained strong, but there have been some signs of trading down because of the weaker euro.
With technology companies, competition is always a threat. Fortinet (Nasdaq: FTNT ) , Sourcefire (Nasdaq: FIRE ) , and recently public Palo Alto Networks (NYSE: PANW ) are the three that I'm watching most closely. All are growing more quickly than Check Point and have highly regarded offerings in different areas of network security, but none yet has the breadth and scale of Check Point's offerings.
Only Fortinet is a true global player right now, but all three companies are early in their development, so that could change quickly. It's worth noting that Palo Alto's chief technology officer, Nir Zuk, was one of Check Point's early employees and was behind some of the company's earlier offerings, and that earlier this year Gartner rated Palo Alto's enterprise offerings in the same class as Check Point.
Foolish final thoughts
Competition is the more important of the two threats, but this is also a growing market with room for more than one major player. Also, switching from one security solution to another isn't a small effort, which should mean we're unlikely to see any fast or large declines in Check Point's installed base. In fact, I expect the company will continue to grow a little bit more quickly than the industry as a whole, which is why I'm happy to add to my position right now.
As a reminder, you can follow along with all my real-money Orange Portfolio trades and updates here.