Check Point's problem isn't Palo Alto

Shlomi Cohen

To see why the company's share price is so low, look at its growth prospects, and at Gil Shwed and Marius Nacht's options.

The company isn't in my portfolio, but the fall in its share price to an annual low prompts me to give another check-up to Check Point Software Technologies Ltd. (Nasdaq: CHKP), the most successful high-tech company to have arisen in Israel. Last week, there was speculation that the fall in the share price in recent months was attributable to investors' nervousness in the face of the forthcoming IPO by a small competitor, Palo Alto Networks, which sounds like nonsense to me. Since when has the IPO of a minor rival been a significant threat to the business of a leading public company?

If Palo Alto, one of the founders of which and its CTO is Nir Zuk, who was with Check Point in its early days, is really such a technological threat to Check Point, then it ought to have hurt Check Point even as a privately-held company, and that hasn't happened. After all, Facebook's dizzying success hit the business of Google (GOOG) and others long before its IPO in May this year.

In my view, Check Point is falling because it is finding it hard to grow, irrespective of competitors, and it's hard because securing the cyber world has become very complicated, with Check Point's historic and highly profitable Firewall no longer the mainstay it was for so many years. Last week, for example, Check Point announced that it would use Radware Ltd. (Nasdaq: RDWR) technology for preventing hacking.

With 40% of Check Point's sales coming from Europe, which is in the midst of a financial crisis, and with the dollar having strengthened substantially against the euro during the quarter, Check Point will apparently struggle to grow at an annual rate of more than 10%. This means that, even though Check Point is a mighty cash generating machine, if its growth rate falls to a single-digit figure, investors will shrink its p/e ratio for the coming year, which currently stands at 14, and its sales multiple, currently 7.

In the past, I did hold Check Point in my portfolio, but I said goodbye to it as soon as the shareholders meeting passed a decision in 2003, that seemed to me scandalous at the time, to award two million options to founder, chairman and CEO Gil Shwed, and one million options to Marius Nacht, his deputy and a co-founder.

Two million options amount to nearly 1% of the company, and I presume that if "Mr. Teva", the late Eli Hurvitz, had received a similar annual bonus for work no less amazing than that of "Mr. Check Point", it would have shocked the capital market.

It seemed to me then utterly fantastic that at the shareholders meeting that took place in the summer of 2003 to approve the 2002 financials, two managers, Shwed and Nacht, received such fat bonuses for 2002, which was one of the worst years ever for the company. In April 2002, it published a severe profit warning that led to the share price nose-diving. The share ended 2002 at $13, 70% below the price at the beginning of that year. I thought at the time that the bonus would be a one-time thing, but it has kept cropping up, slightly altered, year after year, to this very day. There is therefore no chance that I will come back to the share. When I read the notice of the 2012 shareholders meeting, held at the beginning of the month in which Shwed was again awarded 1.6 million options, the penny dropped with me over what had happened in the ten years since the aggressive options program began.

Shwed received altogether 16.7 million options, and his partner Marius Nacht received another few million, the result being that they have by now fortified their control of the company, with a critical blocking minority stake of 25%, which they did not have a decade ago. They have also sold hundreds of millions of dollars worth of shares along the way.

The fact that Shwed receives an annual salary of $1 is only a fig leaf for the aggressive options scheme. Steve Jobs, for example, also took $1 a year, but he did not take options during all of Apple's (AAPL) recent years of plenty. There's a great deal of talk here about tycoons and haircuts, but, in my view, Shwed and his partner, tycoons in every respect, have carried out a transfer of wealth from investors to their own pockets that is no less scandalous, because it is at the public's expense just as a haircut for bondholders is at the public's expense.

Had Shwed and Nacht been more modest in receiving options, as for example Eyal Waldman of Mellanox (MLNX) and Eli Fruchter of EZchip (EZCH), two founders and managers who without doubt are now building the next Check Points, have been, then Check Point shareholders would have been in a much better position today. The company would have had far fewer shares, making earnings per share higher, and that would have translated into a higher share price on the market.

Published by Globes [online], Israel business news - - on June 25, 2012

© Copyright of Globes Publisher Itonut (1983) Ltd. 2012

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