Why Palo Alto Networks is a Great Buy

Author's Avatar
Jul 29, 2015

Despite the fact that Palo Alto Networks (PANW, Financial) has not posted a profit since 2013, the company’s stock has gained considerable weight during the same period on the back of massive revenue growth. Both revenue and stock price have doubled since 2013, and I expect this trend to continue due to PANW’s blooming prospects. Let’s take a look at the company’s potential growth drivers one by one.

Cyber security market

Cyberspace is growing at a rapid space. This is driven by the prolific growth of cloud computing, increasing use of web and mobile, the growth of social media, and increasing scope of Bring-Your-Own-Devices (BYOD) at the workplace, etc.

This growth isn’t expected to slow down any time soon as the need for storing data information is increasing rapidly. Also, the Internet of Things (IoT) landscape is expected to reach a size of 25 billion connected devices by 2020.

With the increase in data storage, the demand for cyber security is also increasing. Every device, sensor, terminal in the entire network is vulnerable to cyber attacks. As a result, the cyber security market is projected to be worth $170 billion by 2020, including both cyber security solutions and services. In particular, the global enterprise security market is expected to grow at a CAGR of 11.84% during 2014 through 2019.

PANW offers a diverse set of a subscription services that will help the company harness this growth. PANW's WildFire cloud-based advanced threat prevention system is already gaining traction as the company’s management said that it had seen an uptick in demand for WildFire in the last quarter. The company has been gaining market share over the last few quarters and given the advantages of its offerings, I expect this trend to continue.

PANW outperformed the expected global enterprise security market growth by clocking consolidated sales growthof 55% year-over-year in 3Q2015, on the back of 67% growth in Americas, 20% in EMEA, and 13% in APAC region.

Balanced product mix

In 2015, managed security solutions will garner 40% share of the total security market. Enterprises find it difficult to manage stand-alone or integrated security network components due to lack of expertise and resources. Hence, they prefer Cloud-based security solutions that are compatible with various data security regulations and offer round-the-clock monitoring.

PANW’s hybrid-SaaS model and subscription based services cater to such customers. Looking at the preference of enterprise customers for cloud-based services, it is not surprising that the recurring services revenue grew a whopping 69% year-over-year and 10% sequentially during 3Q2015.

In addition, the product based revenue increased 44% year over year, primarily driven by data center products where it is gaining market share in this market segment. In fact, the strength of product mix enabled the company to add over 1,500 new customers during 3Q2015, taking the total client base to 24,000.

To strengthen the subscription-based security offerings, PANW announced the acquisition of Cloud app security firm CirroSecure for securing SaaS-based applications like Dropbox and Salesforce (CRM, Financial). Highlighting the acquisition, the company said:

“The addition of the CirroSecure technology to the Palo Alto Networks Enterprise Security Platform provides organizations with this necessary functionality by extending visibility down to the individual file, folder and user that’s operating within the SaaS application.”

This acquisition will further drive the growth of subscription-based services revenue as apps from Microsoft (MSFT, Financial), Google (GOOG, Financial) (GOOGL, Financial), Dropbox, and Salesforce are becoming increasingly pervasive in an enterprise setup.

Competitive advantage

PANW has FireEye (FEYE, Financial) as a credible competitor in the same industry. While FireEye has appreciated 60% in 2015, I think PANW is a better investment. Looking at SG&A as a percentage of revenue PANW is better positioned and FEYE has a lot of catching up to do.

FireEye’s SG&A as a percentage of revenue is over 100%, meaning that the company is spending money at a faster rate than it is generating revenue. By comparison, PANW’s SG&A as a percentage of revenue is 67.55%. Clearly, PANW has spent money more cautiously and has revenue growth to show for it.

As a result of this, while PANW is expected to post a profit in the next four quarters, FEYE will still be posting a loss in the same period. Enterprises are moving to Cloud-based security solutions, and this will be a credible growth driver in the long-term for both the companies, but PANW has an edge over FEYE.

Conclusion

The cyber security market is growing at a staggering pace, and market potential is huge. PANW’s revenue has been growing consistently and for fiscal the same is expected to be 33% more than fiscal 2015. FEYE’s top line is also expected to grow as well, but the company will not be profitable over the next one year. FEYE’s expenses have outpaced its revenue growth and this is not a good sign for long-term investors. While both PANW and FEYE are volatile stocks with presence in a booming industry, I think it would be better if investors consider adding PANW to their portfolios.