Taking Stock: Why Some Stock Prices Stay Low

Check Point Executives disclose very little beyond what's required
I hate the first few weeks after the quarter ends. From morning to night, I listen to conference calls. Some are good, and I break out the champagne. Most merit little fanfare. Then there are those that make me lose sleep. In my 20-plus years of following industries, few have been as baffling as the tech sector. Now and then, I find a tech company that shows good operational and financial metrics but remains out of favor with investors--and some management teams do little to help their own cause.

One case in point is Check Point Software Technologies, a leader in enterprise security apps and systems. As expected, it reported second-quarter earnings per share of 24 cents, down from 27 cents last year. Revenue was down 2.4% year over year but up 1.2% sequentially. Operating margins were 59.3%. Product revenue, roughly 52% of total revenue, declined 5% from the first quarter, while subscriptions and upgrades, about 40% of total revenue, grew 10%. Executives blamed weaker-than-expected product revenue on Asian sales as SARS closed the company's offices for weeks. Fortunately, strong U.S. sales helped offset most of the weakness in Asia. Unfortunately, while its sales in VPN-firewall apps have flattened in the last 12 to 18 months, competitors such as NetScreen Technologies continue to grow. Still, Check Point's operating cash flow remained positive, and cash accumulated on the balance sheet, now totaling $1.5 billion, or almost $6 per share.

After Check Point released its quarterly figures, the stock price sank (down 13.5% to $17.13) as investors questioned where earnings growth would come from. Management clearly has access to the same information I do: Many companies intend to deploy firewall-VPN technology in the near future. Thus, Check Point believes that when businesses increase IT budgets to implement enterprise security, the rising tide will lift all boats. For this reason, I think 10% revenue growth in 2004 isn't a big stretch. Any incremental revenue will be highly profitable since operating expenses aren't highly variable, and earnings growth could be significantly higher than revenue growth.

Management believes now is the wrong time to repurchase shares or pay a dividend. However, a share repurchase would add to earnings per share for current shareholders, and a dividend would increase the shareholder base to include investors who buy only dividend-paying stocks. Check Point hinted on its conference call that it's looking to expand the business, but that could take any form, including buying select technology or acquiring a competitor. If the former, there's plenty of developing technology that could be bought at a modest price. But a larger acquisition would likely require a premium price and integration risk. It's clear that Check Point is a maturing company that would likely see a stock-price boost if it were to pay at least some of the cash to shareholders.

Management discloses little information beyond what's required and avoided topics during its conference call related to uses of corporate cash and internal gross-margin targets. This could create suspicion that management is hiding important business details. That's one reason some stocks remain cheap despite their fundamental virtues.

William Schaff is chief investment officer at Bay Isle Financial LLC, which manages the InformationWeek 100 Stock Index. Reach him at [email protected]. This article is provided for information purposes only and should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any security. Bay Isle has no affiliation with nor does it receive compensation from any of the companies mentioned above. Bay Isle's current client portfolios may own publicly traded securities in one or more of these companies at any given time.