Palo Alto Takes On Big Rivals With Firewall Approach

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Hackers have been out in full force on their search-and-destroy missions in recent months.

In February, for example,Burger King 's ( BKW )Twitter account reportedly was hacked to look likeMcDonald's ( MCD ). The hacker tweeted that Burger King had been sold to McDonald's, and the account had been taken over by Burger King employees.

With attacks like this one on the rise, so too has demand been rising for better network security from companies likePalo Alto Networks ( PANW ).

Palo Alto, which went public in July, has staked its claim in a network security market long led by outfits such asCheck Point Software Technologies ( CHKP ) andJuniper Networks ( JNPR ).

Next-Gen Technology

Founded in 2005, the relative newcomer to the field has taken on its big-shot rivals by coming to market with a key point of differentiation: It pioneered the next-generation firewall technology.

The firewall serves as the barrier between an organization's internal network and the Internet. Palo Alto's next-gen platform allows businesses, service providers and government to secure their networks and safely enable the increasingly complex and fast-growing number of applications running on their networks.

Its approach focuses security on applications and users vs. traditional firewalls, which focus security on the network port and protocols of the data network traffic. Its next-generation firewall delivers application, user and content visibility and control integrated within the firewall through proprietary hardware and software.

Palo Alto's platform has caught on in a big way. Revenue has grown by at least 50% since its market debut. In the most recent second quarter, sales soared 70% to $96.5 million. Profit surged 40% to 5 cents a share. It added more than 1,000 new customers for the fifth straight quarter. At the end of the quarter, it had more than 11,000 customers in over 100 countries.

What's the big draw?

"Its next-generation firewall can block specific Web apps such as Dropbox," said Northland Capital Markets analyst Catharine Trebnick. "Its solution enables the enterprise to specify down to the application level which ones should be allowed to be used by the enterprise."

At a time when there's such a large and growing number of targeted threats, such as the Burger King breach, she says, the next-generation firewall is in "huge demand."

"And Palo Alto is going after these large enterprises with legacy solutions in place and saying 'you need to get rid of that and get the new one.' They were the first to market. So they have first-mover advantage. They have pretty good performance from what I understand."

The traditional firewall approach worked well for basic email and Web browsing applications, which behaved in a predictable fashion and adhered to standard network ports and protocols, according to a company filing with the SEC. But a growing number of applications, such as Web 2.0 and social media, allow users to collaborate and share information on the Internet in ways that weren't possible in the past. These applications, says the filing, have become increasingly more complex and unpredictable and more challenging to the legacy firewall.

That's where Palo Alto's approach comes in: "What Palo Alto has driven is the idea that it's no longer good enough to look at ports and protocols," said Stifel Nicolaus analyst Todd Weller. "You have to look at the application coming in and who's using this application and whether to let it in."

Incumbents, which include network security companies like Check Point and Juniper, have added application control capabilities, Weller says.

But Palo Alto, having that first-mover advantage, also now has a brand advantage.

"The question comes down to whether that's sustainable or not," he adds. "We spend time trying to figure it out. It's a big point of debate in the market."

Meanwhile, says Weller, the market environment for network security is "healthy" amid an increasing number of attacks and more devices accessing the network. All the pure-play network security vendors are benefiting from that.

500 Big Clients

Palo Alto gave some telling signs of its progress in the market at its March 21 analyst day. Palo Alto said 500 companies out of the Forbes Global 2000 are customers, said Trebnick in a note after attending the meeting. Another good sign: 60% of new customers are using Palo Alto as a primary firewall vs. 50% a year ago.

Palo Alto estimates the total addressable market for security will be roughly $13.4 billion in 2016, up from $10 billion in 2012. It pegs its market share at 5%. The company plans to boost share by expanding its major account team lineup to 40 teams from two.

Analysts polled by Thomson Reuters expect the company's full-year profit to grow 50% to 21 cents a share. They see a 110% rise in 2014 and a 68% gain in 2015.

Trebnick says she's heard the demand is there for Palo Alto.

"They're replacing a lot of the legacy firewalls in the Forbes 2000 at the expense ofCisco Systems (CSCO)," she said.

Its customers include JD Williams & Co. Ltd., the United Kingdom's leading home shopping company; Farm Credit Financial Partners, the top provider of technology services to farm credit associations; and wireless telecommunications company Qualcomm (QCOM).



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



This article appears in: Investing , Investing Ideas

Referenced Stocks: BKW , CHKP , JNPR , MCD , PANW

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