Investors Are Overlooking These Pure-Play IT Security Companies

Delian is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Check Point Software Technology (NASDAQ: CHKP), Fortinet (NASDAQ: FTNT), and Palo Alto Networks (NYSE: PANW) are three leading pure-play IT security companies that should benefit from increased use of and dependence on computing power. The difference between the pure-play IT security companies and similar products offered by larger companies is like buying a dollar coffee cup from a gas station and a $5 customized java beverage from Starbucks. The main difference is that IT security is way more important than the coffee we drink.

Industry dynamics

Companies spend billions on securing their computer networks and mitigating damage done by intruders. Some of the best known breaches of public companies' computer systems include:

  • Heartland Payment Systems – In Jan. '09, Heartland Payments announced an IT security breach that affected thousands of its customer accounts. As a result the company's stock dropped 50% from January 15 through 26, 2009.

  • Sony - in a period of several months in the spring of 2011, Sony Entertainment and PlayStation accounts were jeopardized and Sony suspended its network for a few days. The stock declined by 33% from March 1 through June 20 of 2011.

  • Global Payments – On March 30, 2012, Global Payment publicly announced that a breach has occurred and account data was at risk. From March 27 to April 2 of 2012 its common stock declined by 14%.

For comparison, following the September 11 terrorist acts, the S&P 500 declined only by about 12% from September 10, 2001 to September 20, 2001. It is believed that future wars will be fought in cyberspaces and demand for IT security companies should rise in the following major areas: VPN - virtual private networks; firewalls; UTM – unified threat management; IDS/IPS – intrusion detection/prevention services; web gateway; endpoint protection – end device protection; wireless; applications; and advanced persistent threats.

Fundamentals and valuations

 

CHKP

FTNT

PANW

Year founded

1993

2000

2005

Market capitalization

$10.6B

$3.2B

$3.3B

Price-to-earnings (est. current fiscal year)

15.8

40.9

225.1

Operating margin

55.5%

17.6%

-4.5%

Sales growth latest quarter (year-over-year)

3.1%

15.8%

54.2%

Price-to-sales

7.9

5.9

9.3

Price-to-CFO

11.6

18.7

35.9

International sales

55.0%

59.0%

37.0%

Employees

2,706

2,077

1,034

R&D as a percentage of sales

8.3%

15.2%

15.1%

Source: SEC filings, CapitalIQ, Reuters, author's estimates. CFO – cash flow from operations.

Check Point is the company with the largest margins, lowest growth rate and lowest valuation followed by Fortinet and Palo Alto. As the most established company, Check Point is the number two network security provider after Cisco and it has capabilities to gain market share from Cisco as well as Juniper.

Fortinet, the second largest company in terms of revenues, is best known for its high-performance networks, strong UTM solutions, and wireless LAN solutions.

Finally, Palo Alto is known for its next generation firewall and is the disruptive company in the group with the highest growth rates. Palo Alto's products focus on applications where companies can have contextual complexity when users use and access applications, networks and files. Under its land and expand strategy, Palo Alto sells the initial product(s), and in the course of the contract life, convinces clients to buy additional services.

Current developments

Check Point is the only company that is repurchasing its own shares, due to its rock solid balance sheet. In the latest quarter ended March 31, the company repurchased shares worth $131.6 million and plans to repurchase about $125 million on average per quarter through the end of 2014.

Operationally, Check Point is offering two new products: Threat Emulation, preventing in real time infection and shares its findings; and Compliance for regulatory compliance and reduced audit time. It is currently developing products in the cloud and SaaS (software as a service) areas due to the decline in enterprise centers.

Similar to Check Point, Fortinet and Palo Alto are bringing out new products. For example, Fortinet is focused on gaining traction with large enterprises primarily in cloud-based security, mobility, and advanced persistent threats. Its FortiWiFi and FortiAP (access point) offer new secure wireless LAN solutions. Also, it recently acquired Coyote Point Systems, which provides additional application delivery control (ADC) capabilities to Fortinet. ADCs are especially useful in data centers used by mobile carriers.

And finally, Palo Alto, offers a unique technology primarily in application technology. Historically, it has had the most narrow focus primarily on secure use of applications such as Skype, Facebook, and LinkedIn. Palo Alto's newest solutions include WildFire antivirus solution and GlobalProtect firewall and should continue to drive the company's first class growth rates.

Conclusion

IT security importance will grow as use of mobile devices, applications, cloud computing and file transfers continues to increase. Three companies that offer pure-play exposure to the IT security area are Check Point, Fortinet, and Palo Alto. Check Point trades at a discount to the smaller and faster growing Fortinet and Palo Alto, while Fortinet and Palo Alto are more likely to be acquired.

In 2010, Intel acquired IT security company McAfee for $7.7 billion and McAfee generated revenues of $1.87 billion on average in the three years prior to the acquisition. Currently Fortinet and Palo Alto trade at a fraction of that price. While it may take a few years for Check Point, Fortinet and Palo Alto to reach this level of revenues, investors should consider investing in their shares due to the fast growing industry in which they operate. 

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Delian Naydenov has no position in any stocks mentioned. The Motley Fool recommends Check Point Software Technologies. 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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