Palo Alto Networks: Downside Risk Remains Elevated (NASDAQ:PANW)

Palo Alto Networks’ (NASDAQ: PANW) (NEOE:PANW:CA) Shares have held regular in current months regardless of headwinds that will take longer than many count on. Palo Alto’s NGS portfolio continues to carry out nicely, with the corporate’s massive present buyer base, which gives an enormous alternative for cross-selling. Palo Alto is a powerful firm, which suggests the inventory is more likely to carry out nicely over the long run. Nonetheless, its valuation is presently fairly excessive given the deterioration in progress charges and weak demand.

I beforehand urged that Palo Alto’s issues have been understated and that the corporate’s platform technique was a response to weak spot moderately than an try to capitalize on a big market alternative. The info helps this, though Palo Alto could proceed to make use of leverage to assist financials within the quick time period.

Market situations

Palo Alto urged that market situations secure, with a dynamic risk panorama that continues to drive demand for next-generation options, regardless of rising rates of interest and an unsure macro atmosphere, inflicting warning amongst prospects. Palo Alto additionally believes that synthetic intelligence is fueling a resurgence in cloud migrations, driving demand for cloud safety.

Nonetheless, demand varies broadly by product sort as {hardware} is underneath strain resulting from pandemic-related backlog depletion. Fortinet’s ( FTNT ) firewall gross sales are weak, though the corporate expects buyer stock ranges to normalize by the tip of the 12 months. Fortinet has urged it is going to supply offers all through 2024 to spice up gross sales, contributing to pricing strain out there.

Whereas CrowdStrike’s ( CRWD ) financials stay sturdy, the corporate mentioned market situations stay difficult. CrowdStrike’s feedback additionally stay dismissive of Palo Alto’s strategy, suggesting that pooling options is an inferior strategy. Fortinet shares the view.

Palo Alto Enterprise Updates

Palo Alto’s SASE resolution is now deployed with greater than 4,000 prospects, and at any given time, greater than 15 million endpoints are utilizing the product, with one other 50 million utilizing Palo Alto’s VPN product. Whereas competitors is rising, Palo Alto maintains a powerful place within the SASE market. SASE is the quickest rising a part of Palo Alto’s enterprise, with Prisma SASE rising 50% YoY within the third quarter.

Adopting zero belief in governments must also be a tailwind for Palo Alto within the coming years. Palo Alto has been engaged on the Thunderdome mission for 1.5-2 years attempting to promote SASE to the federal authorities. Thunderdome refers back to the Protection Data System Company’s zero-trust community structure. ​​​​​​Whereas this stays a giant alternative that Palo Alto continues to be optimistic about, it’s now more likely to occur over a time frame moderately than instantly. A big single-digit proportion of Palo Alto’s enterprise already comes from the federal authorities.

Palo Alto estimates that its cloud safety enterprise is about 50% bigger than the subsequent largest participant out there, though competitors is rising. For instance, Fortinet is buying Laceworks, which ought to considerably strengthen its cloud safety providing. Regardless that Laceworks went down, the corporate nonetheless has a stable resolution. Palo Alto believes that the hygiene a part of cloud safety is turning into a commodity and that the significance of real-time safety is rising, doubtlessly taking part in into the energy of corporations like CrowdStrike.

Regardless of the weak firewall progress in the mean time, Palo Alto believes the market will ultimately return to its pre-Covid progress pattern (0-5% annual progress). Nonetheless, the migration to the cloud is decreasing the demand for {hardware} and prices are shifting to software program. The expansion of Palo Alto’s software program firewall is about 3 instances the expansion of its {hardware} firewall.

XSIAM can be a powerful level at this level, with $400 million in TCV for the Palo Alto firm within the product’s first 15 months. Moreover, XSIAM raises Cortex’s profile out there. Demand for XDR is reportedly regular, with greater than 5,800 XDR prospects now in Palo Alto.

Cortex’s enterprise must also be supported by a current partnership with IBM that can see IBM prospects transfer from QRadar to XSIAM. IBM will present industry-leading capabilities on XSIAM with watsonx. Palo Alto will develop into IBM’s most popular community, cloud and SOC cybersecurity accomplice. The businesses may even collectively develop cloud safety options. As a part of the partnership, Palo Alto is buying IBM’s QRadar SaaS property, some QRadar IP, and a listing of on-premises QRadar prospects from IBM. The full award is US$500 million plus wage.

Platformization

Palo Alto prospects nonetheless buy greater than 20-30 cybersecurity merchandise, although cybersecurity is just about 6-10% of most corporations’ IT budgets. Nonetheless, transitioning between options will be advanced, and techniques integration work is usually required. Because of this, Palo Alto is paying extra consideration to channel companions.

Palo Alto additionally makes use of incentives to encourage prospects to standardize on its platform. Palo Alto’s platform technique is positioned as an offensive transfer designed to speed up consolidation. Palo Alto plans to make use of incentives to encourage prospects to standardize on its platform, together with legacy exchanges and free introductory gives. That is vital as a result of Palo Alto has urged that the lifetime worth of a buyer utilizing two of its options is 5 instances the worth of a buyer utilizing only one. This quantity will increase to 40 instances for a buyer utilizing all three options. It’s because platform adoption will increase prices and tends to scale back churn.

Palo Alto has reached roughly 900 rigs to this point, with a objective of two,500-3,500 by fiscal 12 months 2030. Whereas this reveals an inexpensive diploma of success, CrowdStrike continues to be fairly dismissive of Palo Alto’s strategy:

We don’t reclassify, checklist or reposition present companies to create perceived platform worth. If the platform gives actual worth, you do not have to offer it away. – CrowdStrike CEO George Kurtz

Monetary evaluation

Palo Alto had $1.98 billion in income within the third quarter, up 15.3% year-over-year. Providers income was up 20% pushed by subscriptions, whereas product income was flat year-over-year. Billings progress was weak, though Palo Alto would not assume billings are a great indicator of the energy of its enterprise. Billing is now being impacted by prospects preferring annual billing plans.

Whereas Palo Alto’s income progress continues to be moderately sturdy, progress is slowing and there seems to be a noticeable drop in income high quality. Palo Alto gives various incentives comparable to reductions, trial durations, deferred cost phrases and financing to assist demand. That is evident from the financing firm’s accounts receivable, which grew by 34% sequentially.

Palo Alto expects first-quarter income of $2.15-2.17 billion, up 10-11% year-over-year. NGS ARR is anticipated to be between US$4.05 billion and US$4.10 billion, a rise of 37-39%. Palo Alto is focusing on $15 billion in next-generation safety ARR by fiscal 12 months 2030, with progress anticipated to stay excessive within the coming years.

The variety of jobs that point out Palo Alto Networks of their job postings stays low, which is indicative of the headwinds the enterprise is presently going through. Palo Alto’s job numbers additionally level to continued weak spot.

Palo Alto’s margins proceed to broaden because the enterprise expands, helped by an finish to produce chain points associated to COVID. Whereas Palo Alto’s profitability will probably proceed to enhance, it is value noting that the corporate’s money circulate is being pressured by buyer incentives. It is also value noting that Palo Alto’s heavy use of acquisitions means it has needed to make investments much less in analysis and growth than a lot of its friends.

Conclusion

Palo Alto is a powerful firm, however I are likely to assume that almost all of that energy comes from its gross sales pressure and present buyer base. Competitors is rising, and a few of Palo Alto’s rivals have compelling options. Whereas a few of Palo Alto’s difficulties are macro-environmental, I additionally assume competitors has an influence.

Palo Alto inventory is more likely to carry out nicely in the long run, however the firm’s excessive valuation and lackluster efficiency make for a dangerous setup within the quick time period. Nonetheless, it is going to probably take a catalyst to ship the share worth down.

For now, Palo Alto’s share worth seems to be extra a results of flows than fundamentals, and the corporate has been added to the S&P500 in mid-2023. Buybacks are probably serving to: Palo Alto purchased again $500 million in inventory within the third quarter.