Palo Alto Networks: A 10-Bagger In 18 Months

Jul.27.12 | About: Palo Alto (PANW)

Palo Alto Networks (PANW) was one hot IPO, with the pricing range lifted from 34-37 on 7/9 to 38-40 on 7/17 and the ultimate pricing at 42 on July 19th. Just over 10% of the 67.5mm shares outstanding (excluding 14.5mm deep-in-the-money options) were sold to the public, with the company selling 5.6mm shares and existing shareholders selling 1.5mm roughly.

My purpose today isn't to provide a complete investment rationale for PANW but rather to share how radically the valuation has changed over the past year. When a new investor looks at the chart, it might look like it is up "only" $5 from its first trade of $55, but the IPO price was $42. In fact, though, the vast of the holders own the stock dramatically lower in price.

How can we tell this? New companies, when pursuing initial public offerings file what is known as an S-1, or preliminary prospectus, which is followed by a final prospectus after the deal is priced. In fact, typically multiple S-1s are filed in advance of the pricing.

In the case of PANW, the S-1/A (7/17) details the historical valuations of the company, beginning on page 74. The valuations support the historical granting of options. PANW details its valuations back to early 2011, when it awarded options with an exercise price of $5.39. To be fair, this price reflected a 20% discount due to the fact that the company wasn't yet public. Even at the beginning of 2012, the company estimated its fair value to be 12.45, with the most recent valuation in early June at 33.02. The stock has almost quadrupled since year-end.

One particularly lucky person is CEO Mark McLaughlin, who joined from the outside last August. His employment agreement highlights a massive equity award in and of itself: 2.156mm options, with a strike price of 10.77. 1/4 of these have vested already. At current prices, he has a paper gain of OVER $100MM. The weighted-average exercise price of all of the options issued before April 2012 is 7.16 (on 12.9mm shares), with an additional 1.56mm issued after April with a 20.19 exercise price.

With the stock currently trading well above the IPO price and touching as high as 61.85, it's worth pondering the risk of additional supply in the future. I have already indicated how much the stock has appreciated for the pre-IPO owners and now the IPO investors as well. Private equity holders (Sequoia, Greylock and Globespan) own almost 50% of the outstanding shares after not participating in the IPO. The deal was priced with a standard 180-day lock-up, so this is one where it is likely we will see some selling at its expiration in early 2013.

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