Check Point struggles for respect

For a hot company in a hot sector, Check Point Software gets little respect on Wall Street. A key reason: Its competition includes Microsoft.

5 min read
REDWOOD CITY, California--For a hot company in a hot sector, Check Point Software gets little respect on Wall Street.

Never mind that Check Point has dominated the firewall market with its See related Newsmaker: CEO takes Check Point beyond firewalls FireWall-1 software. Never mind that it claims to be the No. 1 provider of virtual private networks. Never mind that its security management software controls products from other companies, not just its own.

All that is history. Investors worry about the future.

Mostly they fear that software giant Microsoft and networking powerhouse Cisco Systems will get really serious about security and crush Check Point.

"When you start throwing around names like Cisco and Microsoft--either one of them would be scary enough to an investor," said Deborah Triant, Check Point's U.S. chief executive. "And when you throw both names in at the same time--my God!--it sounds like a scary business."

In January, for example, Morgan Stanley Dean Witter downgraded the company's stock because it speculated that the two giants were headed into Check Point's market sooner than expected.

In April, Microsoft's No. 2 executive and newly named president, Steve Ballmer, told a publication in Israel, where Check Point was founded and maintains research operations, that Microsoft was heading into its territory. Check Point's stock fell 16 percent to 34 and hasn't recovered yet, despite a joint announcement weeks later--conspicuously quoting Ballmer--affirming the Check Point-Microsoft relationship.

Even Check Point's upbeat earnings report last week, with net income of 44 cents share beating the Wall Street consensus of 36 cents, failed to rally the stock, which closed Friday at 24.625. Operating revenues were $34.2 million, up from $18 million a year earlier.

So why does Check Point's stock keep going down?

"That's a question I ask a lot," said Eric Zimits, who's maintained a "buy" recommendation on Check Point for brokerage Hambrecht & Quist for a year. "The implication to certain investors is that company is struggling to generate [revenue] growth, but the company remains very, very profitable."

But Check Point's chief problem is that the firewall market, with which it is closely identified, is in decline.

"We are forecasting that the standalone firewall market decelerates very quickly in next three years," said Jim Hurley, security analyst and consultant with Aberdeen Group. He sees firewall capabilities becoming embedded in network devices like routers or attached to individual desktop PCs or workstations.

"The result of all this is not lost on Check Point, and they've been trying to reposition what they do in the security management space, managing security across multiple devices and services," Hurley adds.

In fact, Check Point's gross profit margins are so fat that they're not considered sustainable. The company has warned Wall Street that in moving from start-up to established player--the company now has 400 employees, half in the United States--Check Point will build a corporate infrastructure, including a low-return technical support operation.

Research costs remain high as the company diversifies into new areas like bandwidth and network management. Check Point also has launched a security consulting business, a near-necessity in the current market, but services are less profitable than products.

"We feel that the company has made no indication how its going to segue out of the firewall market into a higher-growth, less-commoditized business, something that's not in the direct line of fire of Cisco or Microsoft," said Cameron Hight, analyst with CIBC Oppenheimer, which rates Check Point a "hold."

Check Point has for more than a year been positioning itself as more than a firewall company, trying to move into virtual private networks (VPNs), network management, IP (Internet protocol) address management, and security management. But its chief revenue source remains firewall software, where prices are falling.

"They are getting minimal revenues from professional services, bandwidth management, and MetaInfo," an IP addressing firm Check Point acquired in April, Hight said. "So they're pretty much selling a VPN, and that is pretty much a firewall. They're still pretty much a one-product company."

Check Point's Triant sees Cisco has her chief competitor, and she thinks that her company has more than held its own so far.

"I'm optimistic that we can actually become closer, but today they are our biggest competitor," she says. Microsoft is less of a concern because, she argues, network security can't be sucked up into an operating system like browsers or other technologies.

Still, Hight notes, Microsoft's next version of its corporate NT operating system is rumored to include a proxy-based firewall, a completely different technology from Check Point's but one that smaller firms might use instead.

The competitor with the vision that's closest to Check Point's is the acquisitive Network Associates, the former antivirus software firm McAfee Associates that since November 1997 has made a series of security acquisitions.

"Network Associates has made acquisitions to build the product portfolio to make them a security management company," Hight said. "They have intrusion detection, encryption, antivirus software, the firewall--they have the portfolio, where Check Point does not."

But Triant doesn't see Network Associates as a threat.

"Network Associates has made a whole lot of noise and so I'm sure they've had some effect on our stock price," she sniffs. "They don't have an effect on our customers or our channels."

Check Point CEO Deborah Triant on Network Associates
Instead of buying complementary security products, Check Point has chosen to partner through its OPSec Alliance of 140 companies whose products work with Check Point's technology.

"It really enables Check Point to offer best-of-breed products in different aspects of security," says Rakeesh Sood of Goldman Sachs. "They are clearly focusing on their core competency in firewalls and enterprise security management and leaving other tasks to other players who are particularly good at that."

Lately, however, Check Point's partnering has taken on more urgency. On Monday, it announced a deal to sell intrusion detection software from Internet Security Systems under Check Point's brand name. It also is close to a wide-ranging deal with antivirus software firm Trend Micro, a Japan-based competitor to Network Associates' antivirus offerings.

Paul Merenbloom of Prudential Securities, another bull on Check Point, thinks that the company's stock price is being hurt by a split among Wall Street analysts over 1999 revenue and profit projections.

"The fundamental story is still in great shape, but nobody wants to walk into confusion," Merenbloom says, noting that the Internet security market has produced disappointments for investment pros--Cylink, Security Dynamics, and until recently Secure Computing.

"But the fundamental business is a critical one. Check Point provides a set of security-related services critical to practicing safe networking, which is a requirement for Internet and intranet commerce," he added. "The omission of security is not a viable option."