Palo Alto Networks Advances Next-Generation Security

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Last year, security software bySymantec ( SYMC ) blocked more than 5.5 billion malicious attacks on computers, up 81% from the prior year.

These cyberattacks have targeted groups ranging from governments and financial firms to businesses large and small. All manner of computer and software tools are available to resist the onslaught. One primary line of defense is the computer firewall, a combination of hardware and software used to help keep a business network from unwanted intrusion.

Among the providers of firewall gear isPalo Alto Networks ( PANW ), a relative newcomer to the field that has disrupted longtime leaders such asCisco ( CSCO ),Check Point Software ( CHKP ) andJuniper Networks ( JNPR ). The reason for that is Palo Alto Networks pioneered a new method of security protection, known as next-generation firewall technology.

The need for next-generation firewall technology is due to newer methods of computing. Businesses and their employees have increasingly used external software applications available through the Web, including cloud computing platforms. This has greatly increased the number of ways cyberattacks gain entry into a business network.

"So much more traffic is coming in through the Web and the threats have gotten far more complex," said Greg Young, a research analyst at Gartner.

Last year, about $7 billion was spent on firewall technology, according to Gartner. When other elements of security are added in, the estimated market is $10 billion in 2012, growing to $13.4 billion in 2016, according to IDC.

In times past -- thinking of a business like a city -- security experts might have to check only the traffic on freeways and highways. Now, they also have to closely monitor boulevards and side streets. The challenge comes in knowing who to let in and what to keep out.

This is where Palo Alto Networks comes in.

Next Generation

"Until the arrival of Palo Alto Networks' next generation of network security, companies were forced to either allow the use of these applications and suffer the security consequences or block the applications and suffer the productivity consequences," said Mark McLaughlin, chairman, president and CEO, in a conference call with analysts after the company posted quarterly results Sept. 10, its fiscal fourth quarter.

"We are at the confluence of a major technology trend that makes our offerings timely, relevant, defensible and highly differentiated," he said.

Executives of Palo Alto Networks declined to comment for this article due to an imposed "quite period" resulting from plans for a secondary offering. On Wednesday, Palo Alto announced the pricing of 4.8 million shares at 63.

Its technology platform monitors and enables the increasingly complex and rapidly growing number of applications running on computer networks. Companies can continue to use these applications with confidence as Palo Alto Networks provides the ability to inspect all content for all threats in real time across a multitude of software applications, according to the company.

"They've crushed the traditional firewall market with their disruptive technology," said Jonathan Ho, an analyst with William Blair. "It has changed the thinking and caused the other major players to adopt this approach, but from our view Palo Alto Networks has a sustainable edge."

Just like all other technology transitions, competitors must adapt or wither. In the case of next-generation firewall technology, it's not an easy thing to do. Businesses have spent millions installing security gear over the years. Swapping that out for a new platform is not as simple as upgrading software.

"For a lot of legacy products, it's not a natural migration to rip out those products," said Ho. "It's a paradigm shift."

But the change is coming. Gartner estimates 10% of business enterprises have next-generation firewall technology in place. It sees that growing to 38% in 2016.

Palo Alto Networks became a publicly traded company July 20 in a highly successful offering.

The IPO priced at $42 a share, above the expected range of $34 to $37. It began trading at 55, peaked above 62 and finished at 53.13, up 26.5%. It currently trades near 62, about 17% above its first-day close.

The advantage of its early lead in next-generation firewall networks is evident in the revenue growth.

Revenue has grown per quarter at triple-digit rates for most of the last four years. In the September quarter, though, sales growth decelerated to double-digit growth of 88%, to $75.6 million. It posted an EPS loss, minus items, of 7 cents, reversing three prior quarters of profitability. And though Palo Alto exceeded Wall Street estimates, shares fell nearly 6%, though it has since recovered from that drop.

"Investors likely expected stronger guidance to sustain the company's rise in valuation," Ho said in comments at the time.

Revenue Guidance

For the current quarter, its fiscal first quarter, Palo Alto Networks guided revenue in the range of $80 million to $84 million. The midpoint of $82 million would be a 44% increase from a year ago. It expects a profit of 3 cents per share. In the last three quarters it has added more than 1,000 customers per quarter and has more than 9,000 customers overall in about 100 countries.

Asked in the conference call if Palo Alto Networks was seeing any competitive threat coming from Cisco, Check Point or Juniper, McLaughlin said no. "We haven't seen any new releases or introductions by anybody that indicates they're closing the gap."

But it's not that Palo Alto Networks is waltzing through a garden of roses. All the major players are working on the technology transition, includingSourcefire (FIRE). Palo Alto Networks is also facing a patent infringement lawsuit filed last December by Juniper Networks.

"Prior to Palo Alto Networks, the competitors in this field were in a walking race," said Young. "There was not a lot of innovation. They have since lit a fire, and vendors are moving in this direction."

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

This article appears in: Investing , Investing Ideas
Referenced Symbols: CHKP , CSCO , JNPR , PANW , SYMC

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