Check Point’s Money Machine: Each Revenue Dollar Converted to 50 Cents of Profit

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Check Point founder Gil Shwed.Credit: Moti Milrod

Israeli cybersecurity provider Check Point Software Technologies has been consistently growing for two decades, showing large profits while abstaining from risky ventures. Competitor Palo Alto Networks invests large amounts in marketing and development in order to attain rapid growth, but Check Point isn’t bothered by this, sticking to its winning formula – profits first.

In recent years, information security companies are enjoying a booming market. Hacking, widely reported in the media, has included the theft of credit card information as well as business data, in addition to causing mayhem in infrastructure and hospital systems. Giant corporations such as Sony, Yahoo and the Target retail chain have all been hit by such attacks. Companies around the world have started investing large sums in defending themselves against hackers.

The market segment that has benefited from the rising demand includes information security companies that provide advanced solutions that can be installed in addition to firewalls. In 2015, the revenues of companies such as CyberArk, Imperva and FireEye spiked by 45-55%. Palo Alto Networks, Check Point’s largest competitor, showed a 49% increase in revenues in the fiscal year ending in July 2016. Check Point made do with a 9% growth in 2015.

It seemed that Check Point might be benefiting less than others from the increasing demand for cybersecurity. A year and a half ago, Palo Alto reached the same valuation as Check Point even though its quarterly revenues were almost 40% lower and its profits were a tenth of Check Point’s.

However, a different picture emerged last year. The shares of cybersecurity companies fluctuate wildly, and are currently traded at tens of percent lower than their peak values, reached a few years ago. In contrast, Check Point had a very nice return of 30% last year, and its shares are currently just 10% off from their former peak value, attained before the dotcom bubble burst. Check Point has doubled the value of its shares in three and a half years, with the company currently valuated at $17 billion, 30% higher than Palo Alto.

Last week Check Point released its annual reports for 2016, pleasantly surprising analysts with its revenues and profits. The company reported a 7% rise in annual revenues, amounting to $1.74 billion. Its adjusted net profit (non-GAAP) was $818 million, a 6.7% increase over 2015, translated into $4.72 per share, 21 cents above analysts’ predictions.

The strong performance and high profits at Check Point have been repeating themselves for some time, quarter after quarter, year after year. This is definitely an uncommon phenomenon. In the years since it was established, the company has enjoyed revenues of $17 billion, 50% of this racked up as profits.

How does it manage to do this? What is unique about the Israeli software company, allowing it to present such high profits with such impressive stability? Here are some figures that will help understand this phenomenon:

1. 15 years of growth.

Over the past 15 years (except in 2016) Check Point grew each year in comparison to the preceding one. Since 2006 the company’s revenues have grown threefold. The growth rate has subsided over the last five years, currently coming in at an average of 7% annual growth. Within a year or two Palo Alto is expected to catch up with Check Point in revenues, but is far from doing so on the bottom line. Check Point provides both hardware and software, selling its software through a subscription model. Therefore, even deferred revenues – which have grown by 18% in comparison to 2015 – are an indication of the company’s operations.

2. A magical model?

In 1995, three years after Check Point was established, its annual revenues stood at $10 million. Since then, its adjusted net profits have been over 45% of revenues. Its accounting profits also reached almost 40% in all these years. These are impressive numbers by any measure. The NASDAQ-100 index had only three companies that were more profitable last year – the information security company Symantec, the biopharmaceutical company Gilead Sciences and Baidu, the Chinese browser services company. However, it’s hard to think of any other company that has maintained such high profits for 20 years.

The road to achieving such consistently high profits involves maintaining an almost fixed expense structure, which hasn’t changed much since the early years of this millennium. Marketing and sales expenses amount to 20%-25% of revenues, with research and development expenses amounting to 10% of the company’s revenues, or even less. These numbers haven’t changed even in recent years, with Palo Alto breathing down its neck. The hot market could be an opportunity for the company. Check Point believes its model is the winning one, the best one for rewarding its shareholders.

This is apparent in comparing its expense structure to Palo Alto’s. The competing company, established by Nir Zuk, one of Check Point’s first employees, could not have developed a more different DNA. Zuk set himself an ambitious goal when the company was established in 2006 – to overtake the company he grew up in. These efforts are expressed in the company’s expenses to date – two thirds are invested in marketing and sales, with one fifth going to research and development. Palo Alto is utilizing the market’s momentum in order to grow rapidly, realizing that the rate of growth in its expenses will diminish in the future while revenues continue to climb, which will lead to high profits.

The risk to Check Point lies in its low expenses on research and development – $160 million compared to Palo Alto’s $285 million. Check Point has managed to sustain its lead even with the low investment in R&D, but competition is stiff in this field and many investors believe it should invest more in technology through in-house development or acquisitions.

Check Point's Nasdaq share price

Last year Palo Alto’s adjusted net profits were $152 million (11% of its revenues), with accounting net losses amounting to $250 million. This is a far cry from the annual net profit chalked up by Check Point – $818 million.

3. Controlling shareholders.

Check Point was established by Gil Shwed, current CEO Marius Nacht and Shlomo Kramer, who left the company in 1999 and became involved in establishing many other similar companies. Shwed holds 17% of Check Point’s shares while Nacht own 13%. Cofounders holding 30% of a company’s shares for such a long period after its establishment is not a common sight in companies of this magnitude.

Many high-tech companies look after their managers and employees first, believing that in the long run this will benefit the company and its shareholders. This priority is expressed as large outlays on share-based rewards. At Check Point the managers are also the largest shareholders, and this may be the reason for the fact that at Palo Alto compensation from shares is 29% of revenues, compared to only 4% at Check Point.

4. Buy-back of shares.

Check Point doesn’t distribute dividends. It buys back its own shares. Shwed has told TheMarker in the past that “as a shareholder I should be interested in dividends since I’d be the main beneficiary but I nevertheless prefer to buy back shares, since this is what shareholders prefer. This is justified over the long run since share values increase, which is good for investors.” Last year Check Point bought its own shares to a tune of one billion dollars. In fact, the entire positive cash flow was returned to shareholders. The number of shares the company owns dropped by 5% in one year. The company now has $3.7 billion in its coffers.

5. Growth engine.

Although Check Point is growing at a single-digit rate, it shows higher growth rates from software blades, advanced security solutions that can be added to a firewall. These can be products that prevent leakage of data, or ones labeled “threat prevention.” These tools take incoming files and run them in neutral environments while trying to decipher if they are legitimate or malicious.

Revenues from such tools grew by 22% in 2016, a lower growth rate than at most cybersecurity companies. Nevertheless, these revenues comprise a bigger portion of the company’s operations, amounting to 22% of all revenues, compared to 20% in 2015 and 18% the year before that.

Behind this growth is the development of new products and solutions – the company released a new tool which can hold more software, endowing it with more potential for revenues. After the reports came out, Shwed said that 85% of the company’s new sales consisted of these new products, with most clients now buying more software solutions than before.

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