Palo Alto Networks: Likely Guidance Cut Incoming

da-kuk

Palo Alto Networks (NASDAQ:PANW) is scheduled to report earnings for Q4 FY 2023 on Friday. 18th August. I am cautious going into earnings, as I believe the cybersecurity giant will likely announce results below expectations. The argument for a consensus miss is supported by a negative cross read from Fortinet's (FTNT) Q2 results, which highlighted challenging macro dynamics likely to weigh on enterprise customers' short-/mid-term cybersecurity spending.

Looking beyond a likely disappointing Q4 FY 2023 print, Palo Alto's business outlook is also pressured by accelerating competitive dynamics, as Microsoft is chasing opportunities in the enterprise cybersecurity market. Defying a deteriorating fundamental backdrop, Palo Alto stock continues to trade at an enormously proud valuation, pointing to an EV/Sales of ~10x and an EV/EBIT of ~42x.

Going into earnings, I advise reducing exposure to PANW stock.

For reference, PANW shares have outperformed vs. the broader stock market YTD: Since January 2023, PANW shares are up only about 57%, as compared to a gain of "only" 17% for the S&P 500 (SP500).

Seeking Alpha

Palo Alto Networks is set to publish earnings for Q4 FY 2023 on August 18th. And based on information collected by Seeking Alpha, 37 analysts have submitted their estimates, as of August 13th. Projections suggest that the U.S. based cybersecurity giant will likely report a topline in the range between $1.94 billion and $1.97 billion, with the consensus at midpoint being anchored around $1.96 billion. Notably, this is quite a tight range of possible outcomes, causing a topline miss, if delivered, to likely send shockwaves through analysts' valuation models. Using the consensus estimate as a reference point, it is suggested that PANW Q2 sales may expand by approximately 26% YoY versus the same period in 2022.

Seeking Alpha

With regard to profitability, EPS expectations for PANW's Q4 FY 2023 are projected in the range of $1.26 and $1.34, with $1.28 being the consensus, suggesting a YoY EPS growth of approximately 61%.

Seeking Alpha

Notably, PANW's Q4 FY 2023 expectations have been steadily trending upwards since the past 3 years; and, even though peer Fortinet recently delivered a strongly disappointing June quarter, as well as FY 2023 guidance cut, PANW estimates have not budged.

Discussing Palo Alto's Q4 FY 2023 preview, I would like to point investors' attention to a recent press release, dated August 2nd, that communicates management's intention to update fiscal year 2024 guidance and medium-term financial targets until fiscal year 2026, including a review of the company's strategy, product roadmap, financial goals. The company announced (emphasis added):

In addition to reporting Q4 results and providing fiscal year 2024 guidance, management will update medium-term financial targets through fiscal year 2026. With fiscal year 2024 being the final year in the company's prior medium-term outlook, CEO Nikesh Arora and other members of the executive team will provide a review of company strategy, including product roadmap, go-to-market, financial objectives and total addressable market to provide an updated view of Palo Alto Networks' market opportunity and investment thesis.

While it is certainly speculative to argue that Palo Alto will use the special conference to cut financial targets, I argue bracing for such an outcome would not be unreasonable, especially considering Fortinet's most recent guidance cut. Pointing to a deceleration in customers' IT spending due to economic uncertainty, which prompted an "unusual number of deals being postponed", Fortinet cut its revenue projection for the year to a range of $5.35 billion to $5.45 billion, vs. a previous upper limit of $5.49 billion. Admittedly, as compared to Fortinet, Palo Alto has a higher share of revenue coming from ARR than one-off sales, rendering the company somewhat less vulnerable to cyclical swings; however, needless to say, similar macro dynamics that affect Fortinet will likely also affect Palo Alto.

In FY 2022, Microsoft's (MSFT) security-related business topped $20 billion in sales, up 33% YoY vs. FY 2021. Accordingly, Microsoft is a formidable competitor to cybersecurity pure-players such as CrowdStrike (CRWD), Palo Alto, and Zscaler (ZS). What should concern investors, however, is the company's ambition to grow even larger within the global cloud/security market: In a recent memo, CEO Satya Nadella recently shared Microsoft's ambitions to bring the company's topline for cybersecurity to about $100 billion by FY 2030.

In that context, Microsoft recently introduced the Microsoft Entra Internet Access and Microsoft Entra Private Access - products that target Palo Alto's sweet spot SAM of enterprise-focused security edge. For context, the Microsoft Entra Private Access service introduces an alternative to long-standing virtual private networks (VPNs), which facilitate remote employees' access to internal software; while the Microsoft Entra Internet Access serves as a tool for security administrators to effectively manage employees' connections to cloud applications, including integral Microsoft 365 tools such as Teams.

Reflecting analysts' estimates for Palo Alto's Q4 FY 2023 results, I see a downside in the spread of what is expected vs. what the company may actually deliver. Specifically, investors should consider that Palo Alto Networks increasingly needs to strategize in an increasingly challenging macroeconomic and competitive dynamics. Accordingly, there is a possibility that together with Q4 FY 2023 results Palo Alto may cut its financial targets, similar to what Fortinet recently did.

Going into earnings, I advise reducing exposure to PANW stock - as I am worrying about an earnings miss that may serve as a catalyst for a negative share price momentum toward below $100/share, where I continue to see the company's intrinsic value.

Palo Alto Networks CEO Nikesh Arora: ‘Disrupt Ourselves,’ Transform The Industry

CRN’s No.1 Most Influential Executive, Palo Alto Networks’ Nikesh Arora, is transforming the company into a complete unified platform for modern cybersecurity.

Having finished interviewing for the CEO role at Palo Alto Networks, Nikesh Arora got word from the company’s board that he was, in fact, going to be offered the job.

Arora’s own interview process wasn’t done yet, though. While he knew the business side of his resume was stellar—he’d previously been the No. 4 executive at Google and was later the No. 2 executive at investment giant SoftBank—Arora was also self-aware about what he lacked for the top role at a major cybersecurity vendor.

Namely, any sort of background in cybersecurity.

And so before moving forward in the hiring process, Arora asked to talk with two more people: the company’s founder, Nir Zuk, and chief product officer, Lee Klarich.

In those conversations, Arora had two potentially uncomfortable agenda items to discuss. Not only would he need a lot of their help in getting him up to speed, but as soon as he was, he had no interest in maintaining the status quo at the company, which was then largely focused on firewalls.

“I said to them, ‘Listen, I’m coming in and I don’t understand a lot about security, so I’m going to rely on you, No. 1,’” Arora recalled during an interview with CRN in July. “‘And No. 2, I might have some disruptive, nonconventional ideas—so you should understand what you’re signing up for.’”

The response couldn’t have been more supportive: Both Zuk and Klarich “wholeheartedly embraced the idea that we were going to be disruptive and do something different,” Arora said. And over the ensuing five years, Palo Alto Networks has gone on to expand from a network security vendor into a platform covering most of today’s essential cybersecurity capabilities—from protection for cloud and applications, to secure remote access and zero trust, to AI-powered threat detection and security operations.

While looking to reinvent an entire industry and create a new paradigm in cybersecurity, Arora said embracing a “constant desire to disrupt ourselves” has been the key.

Arora’s success in transforming Palo Alto Networks into a comprehensive, unified platform for modern cybersecurity has earned him recognition as the No. 1 Most Influential Executive on CRN’s 2023 Top 100 Executives list.

From overhauling the company’s product portfolio to doubling down on partners—including a pledge to spend 70 percent of his time on go-to-market and the channel in coming years—Arora brings a curiosity and openness to new ideas paired with a tenacity to execute on the vision, according to those who know him.

“He gets super excited when he sees something that could help clients become more secure,” said Rex Thexton, a senior managing director at Accenture, No. 1 on the 2023 CRN Solution Provider 500, who has worked closely with Arora over the course of a five-year strategic partnership between the companies. “When he gets in a room, he lights it up,” he said.

Part of Arora’s openness to different ideas and directions clearly comes from the fact that he was something of an outsider comng into the CEO role at the company, said Lee Waskevich, vice president of security at Herndon, Va.-based ePlus Technology, No. 28 on the 2023 CRN Solution Provider 500.

“I think coming in, not having cut his teeth across the cyber space, has allowed him some freedom and flexibility to try new things that maybe others weren’t willing to do,” Waskevich said. “I think that’s paying off.”

As Chicago-based Accenture and Palo Alto Networks have worked to ramp up their strategic partnership in recent years, Arora has brought a level of commitment to making the partnership successful that’s unusual for a high-powered executive, according to Accenture’s Thexton.

During quarterly meetings about the progress of the partnership, for instance, “there were times when either side was not meeting those goals and objectives” that everyone had agreed to, Thexton said.

After hearing others describe the barriers to meeting the goals, Arora “would break them down, and he would just say, ‘OK, we can do this to take care of that issue. We can solve this issue by doing this,’” Thexton recalled. “And he just systematically would break it down and push it through, where a lot of [CEOs] would just say, ‘Just do it.’”

As a core part of its growth strategy, Palo Alto Networks has been broadening its work with channel partners, which are involved in generating more than 95 percent of its revenue. For solution providers of all sizes, from the giants like Accenture down to MSSPs with a few dozen employees, the company has increasingly become a go-to security vendor, according to solution provider executives.

The partner opportunities are being driven in part by greater demand for a variety of services, both professional and managed. Such services, according to Arora, are crucial to help customers get the full benefit of technologies such as secure access service edge, a cloud-delivered architecture aimed at providing secure access for distributed workforces.

Likewise, when it comes to other newer areas such as cloud security and Security Operations Center automation, Palo Alto Networks partners are playing a pivotal role in enabling customer adoption, Arora said. “If you look at the first two quarters of this fiscal year for us, the proportion of business we do through some of the key partners who are building services capability has increased,” he said. “Whether it’s our traditional partners’ services teams or transformation teams or cloud adoption teams—or whether it’s MSSPs with network transformation skills, or systems integrators with cloud security skills or SOC transformation skills—you are seeing a clear trend toward more solution orientation [by partners] for the customers,” Arora said.

A central part of what Arora-led Palo Alto Networks has done differently from the rest of the industry is the focus on building out a true cybersecurity platform, solution provider executives said. Importantly, the company’s approach has emphasized being able to still offer security capabilities that are “best of breed” even while offering seamless integration between the tools, executives said. Arora and Palo Alto Networks set out on the platform journey at a time when many still thought buying best-of-breed point products, and stitching them together, was the only way to get optimal security outcomes.

“We had our fair share of naysayers early on,” Arora said. “Hopefully we’re on our way to proving them inaccurate.”

To assemble its platform, the Santa Clara, Calif.-based company spent years acquiring leading technologies—there have been 14 acquisitions under Arora to date—and then tightly integrating them together. The deals have largely proven successful and have totaled more than $3 billion, according to Shaul Eyal, managing director for equity research at investment bank TD Cowen.

“Nobody initially expected that he’s going to embark on that sizable acquisition phase,” Eyal said. “I think his ability to come in with an unbiased view of the market and then understand the benefits and challenges ahead, strategize and execute accordingly, and then bring everybody around him toward that same goal—that has all coalesced into the success we’ve seen in recent quarters.” The bottom line, he said, is that “we’re beginning to see Palo Alto [Networks] leading the pack.”

As customers look to reduce the number of security vendors they work with, Palo Alto Networks is “in the right place at the right time because of all the execution they’ve done over these years to put them in that pole position,” said Mark Jones, founder and CEO of Austin, Texas-based BlackLake Security, No. 282 on the 2023 CRN Solution Provider 500.

Arora has never been “chasing the ball,” Jones added. “He’s well ahead of it.”

For Optiv, No. 24 on the 2023 CRN Solution Provider 500, Arora’s strong vision and “clear focus on platform” have helped to drive major growth opportunities with customers, said Alan Mayer, senior vice president of partners, alliances and ecosystems at the Denver-based company.

“The solutions that we can provide, and the platform and the breadth of the portfolio that Palo [Alto Networks] can provide—that all culminates in better outcomes to help our shared customers be successful,” Mayer said.

Looking ahead, Palo Alto Networks’ investment over the years into AI/ML capabilities is looking to pay off as well, with the arrival of generative AI creating huge interest from customers in using it to improve security, solution provider executives said.

With Arora and Palo Alto Networks, “there has definitely been clarity that this is an area they’re investing in and prioritizing,” Mayer said. “Just like the other areas that they’ve focused on, they’ve demonstrated leadership capabilities [in AI].”

Palo Alto Networks expects to capitalize on the technology through utilizing generative AI in forthcoming security products, including tools to prevent threats that are, ironically, assisted by apps like OpenAI’s ChatGPT, Arora said.

Ultimately, with a market capitalization of nearly $74 billion as of this writing, Palo Alto Networks is easily the top-valued publicly traded cybersecurity vendor and getting closer to reaching Arora’s goal of becoming the first to reach a $100 billion valuation.

That doesn’t mean Arora thinks he has it all figured out, though. Far from it: Even five years in, “I still don’t know enough,” he said.

And as much as ever, when he doesn’t understand something, “I’m very open about not knowing it,” Arora said. He noted that his next two phone calls that day were going to be on technical aspects of security—“because I have a few questions.”

Kyle Alspach is a Senior Editor at CRN focused on cybersecurity. His coverage spans news, analysis and deep dives on the cybersecurity industry, with a focus on fast-growing segments such as cloud security, application security and identity security.  He can be reached at kalspach@thechannelcompany.com.

Is Palo Alto Networks (PANW) Stock Fairly Valued?

The stock of Palo Alto Networks Inc (NASDAQ:PANW) has seen a daily loss of -2.15%, and a 3-month gain of 9.74%. With an Earnings Per Share (EPS) of 0.63, we aim to answer the question: Is the stock fairly valued? This valuation analysis will provide insights into the financial health and growth prospects of Palo Alto Networks.

Palo Alto Networks is a California-based cybersecurity vendor offering product solutions in network security, cloud security, and security operations. With a global client base of over 85,000 customers, including more than three-fourths of the Global 2000, Palo Alto Networks has established a significant presence in the cybersecurity industry. As of August 17, 2023, the stock price stands at $209.37, with a market cap of $64 billion. The GF Value, our proprietary measure of the stock's intrinsic value, stands at $192.93, indicating that the stock is fairly valued.

Is Palo Alto Networks (PANW) Stock Fairly Valued?

The GF Value is a unique measure of a stock's intrinsic value, calculated based on historical trading multiples, a GuruFocus adjustment factor, and future business performance estimates. The GF Value Line provides an overview of the fair value at which the stock should ideally be traded. If the stock price is significantly above the GF Value Line, it is considered overvalued, and its future return is likely to be poor. Conversely, if it is significantly below the GF Value Line, its future return is expected to be higher.

At its current price of $209.37 per share and a market cap of $64 billion, Palo Alto Networks stock is estimated to be fairly valued. As a result, the long-term return of its stock is likely to be close to the rate of its business growth.

Is Palo Alto Networks (PANW) Stock Fairly Valued?

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Investing in companies with low financial strength could result in permanent capital loss. Therefore, it's crucial to review a company's financial strength before deciding to buy shares. Looking at the cash-to-debt ratio and interest coverage can give a good initial perspective on the company's financial strength. Palo Alto Networks has a cash-to-debt ratio of 1, which ranks worse than 66.69% of companies in the Software industry. Based on this, GuruFocus ranks Palo Alto Networks's financial strength as 6 out of 10, suggesting a fair balance sheet.

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Is Palo Alto Networks (PANW) Stock Fairly Valued?

Investing in profitable companies carries less risk, especially in companies that have demonstrated consistent profitability over the long term. Typically, a company with high profit margins offers better performance potential than a company with low profit margins. Palo Alto Networks has been profitable 0 years over the past 10 years. During the past 12 months, the company had revenues of $6.50 billion and Earnings Per Share (EPS) of $0.63. Its operating margin of 2.3% is worse than 50.77% of companies in the Software industry. Overall, GuruFocus ranks Palo Alto Networks's profitability as poor.

Growth is probably the most important factor in the valuation of a company. GuruFocus research has found that growth is closely correlated with the long term performance of a company's stock. The faster a company is growing, the more likely it is to be creating value for shareholders, especially if the growth is profitable. The 3-year average annual revenue growth rate of Palo Alto Networks is 22.1%, which ranks better than 77.28% of companies in the Software industry. The 3-year average EBITDA growth rate is -17.4%, which ranks worse than 80.63% of companies in the Software industry.

Another method of determining the profitability of a company is to compare its return on invested capital to the weighted average cost of capital. Return on invested capital (ROIC) measures how well a company generates cash flow relative to the capital it has invested in its business. The weighted average cost of capital (WACC) is the rate that a company is expected to pay on average to all its security holders to finance its assets. When the ROIC is higher than the WACC, it implies the company is creating value for shareholders. For the past 12 months, Palo Alto Networks's return on invested capital is 0.83, and its cost of capital is 9.59.

Is Palo Alto Networks (PANW) Stock Fairly Valued?

In summary, the stock of Palo Alto Networks is estimated to be fairly valued. The company's financial condition is fair, and its profitability is poor. Its growth ranks worse than 80.63% of companies in the Software industry. To learn more about Palo Alto Networks stock, you can check out its 30-Year Financials here.

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This article first appeared on GuruFocus.