Check Point: Q1 Results Are Concerning For The Broader Market
Summary
- Check Point's first quarter results were weak, and performance may deteriorate further going forward.
- Underperformance was concentrated in products, which management primarily attributed to refresh projects in quantum appliances.
- Given the deteriorating macro environment and Q1 results reported so far, investors should be prepared for an ongoing slowdown in software sales.
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Check Point Software (NASDAQ:CHKP) is a legacy cybersecurity vendor that has been generating large amounts of free cash flow with limited growth, particularly given recent strength in cybersecurity spending. First quarter results disappointed on the top line and have contributed to growing concerns about the general state of software spending.
Based on earnings reported so far, the slowdown in software sales appears to be ongoing. Cloudflare's (NET) first quarter 2023 results came in weaker than expected, which surprised many given the management teams previous confidence and history of outperforming guidance. AWS (AMZN) revenue growth was approximately 16% in the first quarter of 2023 and could soon be in the single digits based off observations in April. CDW (CDW) recently pre-announced Q1 2023 sales figures, which came in significantly below expectations. Management attributed the poor performance to macro uncertainty causing customers to delay spending.
Check Point offers a broad portfolio of solutions, covering areas like cloud security, network security, user and access security and security operations. The company got its start in hardware, with products like firewalls and VPNs, and while it continues to grow and maintain high margins, its product portfolio hasn't allowed it to capitalize on the tremendous recent cybersecurity opportunity.
Check Point is investing to try and improve its competitive positioning though, with recent product introductions including:
- Infinity Global Services - end-to-end cyber security services
- Security Operation Center Services with Horizon XDR/XPR
- Cloud Native Application Protection
The products represent entries into competitive markets with strong incumbents, meaning it is unlikely that they will turn Check Point's fortunes around.
Check Point reported revenue in line with guidance in the first quarter of 2023, achieving approximately 4.3% YoY growth. Calculated billings declined 3% YoY as less customers were willing to pay upfront for multiyear deals.
Product revenues declined by 7% YoY, which management attributed to extended sales cycles and deferred projects as a result of macro uncertainty. These were mainly refresh projects in Quantum Appliances. The market reaction to Check Point's results may have been exacerbated by the fact that many hardware companies have large backlogs that they are still working through, and hence product revenue growth could have been expected to be strong. Check Point's management has stated that they have largely kept up with orders though and didn't have a large backlog.
Security subscriptions increased by 13% YoY, with CloudGuard and Harmony E-mail performing particularly well. Infinity revenues also increased by 140% YoY. 81% of Check Point's revenues are now recurring, which refers to subscription revenues plus support and maintenance revenues.
Revenue growth in the first quarter is expected to be approximately 3% YoY at the midpoint, with growth for the year still expected to be approximately 4%. Check Point's management appears to be expecting the market to stabilize or even reaccelerate slightly from current levels, which creates downside risk if conditions continue to deteriorate. New product introductions could be expected to contribute to growth somewhat, but given Check Point's size, it is not clear new products will be material in the near term.
Figure 1: Check Point Revenue Growth (source: Created by author using data from Check Point)
Despite market uncertainty and the tough macro environment, management remains reasonably optimistic. Check Point's sales people are generally positive about the second quarter, as the pipeline has expanded. This is a common observation across cybersecurity companies though, and Check Point must still find a way to convert its pipeline. Search interest could indicate that demand is beginning to stabilize, but this is a noisy indicator.
Figure 2: "Check Point Pricing" Search Interest (source: Created by author using data from Check Point and Google Trends)
Job openings mentioning Check Point in the job requirements indicate that adoption of Check Point's products is not increasing significantly. This metric has trended downwards particularly sharply over the past 12 months, which could indicate further growth weakness going forward.
Figure 3: Job Openings Mentioning Check Point in the Job Requirements (source: Revealera.com)
Check Point's margins are often pointed to as one of the most attractive aspects of the company, but it should be noted that margins have been steadily declining for the past decade, which will become increasingly problematic going forward if the trend continues. Check Point's gross margins have been relatively stable over this period, meaning the decline in margins is due to rising operating expenses. Management has stated that despite the tough competitive environment, discounting has only increased marginally.
The burden of sales and marketing and R&D expenses are likely to rise if Check Point continues to launch new products, although it is not clear the company has any other choice.
Figure 4: Check Point Operating Profit Margins (source: Created by author using data from Check Point)
Job openings at Check Point have been depressed in 2023, which further supports an expectation of ongoing weakness. Check Point is not planning on increasing its sales force significantly this year, due to the economy.
Figure 5: Check Point Job Openings (source: Revealera.com)
Check Point currently has 3.6 billion USD cash on the balance sheet which could potentially be used for M&A. Given the current state of the market, there could be companies that find themselves unable to raise the capital necessary to continue financing operations in the near future. Check Point would be prudent to prepare themselves to potentially pickup attractive assets at depressed prices if the current downturn becomes extended.
Given this, it is somewhat odd that Check Point has repurchased approximately 1.3 billion USD worth of shares over the past 12 months. Check Point's stock isn't particularly cheap given the current interest rate environment and Check Point's long-term prospects.
Figure 6: Check Point PE Ratio (source: Seeking Alpha)
Check Point's product sales should also be concerning for other security hardware focused companies. F5 Networks (FFIV) already reported reasonably strong product sales in the first quarter of 2023, although product sales have now essentially been flat for the past 18 months. Palo Alto (PANW) and Fortinet (FTNT) are both yet to report results and could fall significantly if performance disappoints, as both companies are currently investor favorites and have relatively high valuations.
This article was written by
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