Palo Alto Networks: Still A Compelling Growth Opportunity?

| About: Palo Alto (PANW)

Summary

PANW continues to benefiting from the intersection of several secular growth drivers.

The key consideration is whether or not Palo Alto's growth can be sustained.

The Proofpoint partnership is just another example of how PANW has continued to pursue positive R&D and partnership efforts to keep itself the best-of-breed security solution.

Despite its valuation, Palo Alto continues to be a strong growth opportunity given a pullback.

Management's lowered Q3 guidance sets the company up for yet another earnings beat.

Palo Alto Networks (NYSE:PANW) is a network security solutions provider with an emphasis on next-gen firewall software. The company has built a unique approach to firewalls with a focus on security around applications and users, instead of portals and processes. In addition, the company's firewall solutions do not interfere with normal network efficiency. Right out of the gate, PANW was slated as a leading market disruptor with an early mover advantage. Since its IPO in 2012, PANW has seen near nosebleed valuations, justified by significant revenue growth, and hasn't come down since.

The big question for analysts and investors was whether or not Palo Alto Networks would be able to sustain the incredible growth and innovation that it began with. Looking at the most recent quarterly reports and the company's strategic actions towards partnerships, Palo Alto continues to be a compelling investment. First, benefiting from the intersection of several positive growth drivers including:

1) Exposure to the accelerating secular trends of cloud, mobile, data centers and Internet.
Network security continues to benefit from more and more companies adopting Big Data by collecting and harnessing their customer data, and as data and bandwidth grows the demand for cyber security solutions will as well. There is an incredible market size and opportunity currently. Gartner estimates the security software market to be over $21.4bn worldwide. The highest growth areas are security information management, secure web gateway, and enterprise data security.

2) Increased cyber threats
Within the past year, there have been hundreds of cyber attacks on enterprise networks with 10 high profile breaches including Hilton, Samsung and Anthem. I wrote an article last year outlining the biggest cyber attacks of 2014 as well as the rising demand for cyber security offerings, and the same theme applies to 2015 and this year as well.

3) Specialization advantages
PANW has and advantage from its pure play stance in network security, allowing it to focus on next-gen firewall and related product offerings as its first priority. Two competitors Juniper Networks (NYSE:JNPR) and Cisco (NASDAQ:CSCO) have each found it harder to pivot and innovate due to their lack of focus in areas that Palo Alto Networks specializes in.

The Best-of-Breed Solutions

Palo Alto's solutions include network security appliances and subscription services. Network security appliances can be used to identify application traffic, app enablement, and content scanning. The company's subscription services include threat prevention, URL filtering to control employee Internet access, GlobalProtect for mobile solutions, and WildFire as malware prevention.

Palo Alto's Still Got It...

Palo Alto's unique approach towards network position, and what essentially gives it the innovative kick and advantage against competitors, is its focus on application security and emphasis on enabling networks. In a nutshell, PANW is able to identify, secure, and eliminate cyber threats within a network without hindering its processes and efficiency.
In addition, Palo Alto pipeline is seeing very healthy levels of development. Despite aggressiveness from its main competitors, PANW has maintained its superiority within next-gen firewalls and has a proven architecture that allows customers to easily upgrade and integrate new security streams.

The key consideration is whether or not Palo Alto's growth can be sustained, especially up against a stronger cohort of competitors from every segment of its business. Within firewall players, the primary competitors are Check Point (NASDAQ:CHKP), Cisco's network security division, Fortinet (NASDAQ:FTNT), and Juniper (JNPR) within larger enterprise network providers. Barracuda Networks (NYSE:CUDA) is an example of a player that focuses primarily on smaller business and networks. In web security, PANW is up against giants like Symantec (NASDAQ:SYMC) after its recent Blue Coat acquisition, Cisco after its acquisition of Iron Port, and Websense among others.

Palo Alto boasts the strongest growth out of its security cohort; however it also holds the highest valuation Click to enlarge

Going forward, Palo Alto needs to maintain the several growth drivers that it already leverages in the industry. Greater investment in sales and marketing will continue to fuel the company's customer acquisition pipeline. Also look for Palo Alto to continue its healthy product development efforts and expanding its solutions suite. Subsequently, the company can build on its current customer deployments with repeat orders and upgrades. From its past FY Q4 15 report, Palo Alto announced that an increasing amount of its business is coming from data center, a direct result of its partnership with VMWare, proving to be a key partner in securing software data centers.

On the topic of strategic partnerships, Palo Alto Networks and Proofpoint announced a partnership in Jan 2016 that will provide their shared customers with greater network visibility and automated protection and prevention across enterprise infrastructure. This comes from the harmony between Proofpoint's Targeted Attack Protection solution and PANW's next-gen firewall platform. Customers are increasingly looking for security companies to leverage their specific security offerings and Proofpoint PANW seems to be heeding to that message. When an unknown email is sent to a company, the file will be sent to both Proofpoint TAP as well as Palo Alto WildFire to be analyzed. If it is deemed risky, TAP will block it while WildFire distributes new protections to all interfaces involved. The same can be applied to incoming messages on social media. The new customer benefits coming from the integration of the two security offerings give a notable incentive for new customers to incorporate both systems into their networks. The Proofpoint partnership is just another example of how PANW has continued to pursue positive R&D and partnership efforts to keep itself the best-of-breed security solution.

... And Palo Alto's Still Expensive

Looking at Palo Alto's most recent Q3 beat, reporting $348.5mm revenue growing at an astounding 48% YoY, as well as its recent partnerships and product developments, the company has handily kept up with its lofty expectations. The biggest factor around Palo Alto was its capability of sustaining its growth and the Mark McLaughlin has successfully steered the company upwards so far.

However, when it reported, the stock plunged off of a weak management guidance. Going off of the developments in product and partnership that the company has taken on, the management may just be setting a lower bar for yet another earnings beat next time around. Although Palo Alto continues to be a strong company with very promising future opportunities, it is still valued at an EV/Sales multiple significantly higher than its competitors. Some may argue that PANW deserves this higher valuation according to its equally high sales growth; however, the question is whether or not the company has room to run. Seeing that the long-term prospects are rosier than ever, it may be ideal to jump on a larger pullback in the stock.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.