Palo Alto Networks' Cybersecurity Transformation Is Yielding Results

Cybersecurity leader Palo Alto Networks (NYSE: PANW) settled into familiar territory for its fiscal 2020 first quarter: double-digit revenue growth driven by an aggressive strategy of acquiring smaller niche outfits. Not all investors have been happy, however. Though it's a large operation, Palo Alto is still sacrificing profits for expansion, as the cybersecurity industry is growing -- but also changing -- fast.

Like it or not, the strategy is having the desired effect. Palo Alto has been averaging one major purchase a quarter since the start of 2018, and it's helping the security software suite outpace average industry growth and transition to the future.

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Image source: Getty Images.

Becoming all things to all companies

Changes in technology in the last decade have made security a complicated mess. To solve for evolving needs (like cloud, automation, and software-based products), lots of cybersecurity start-ups have popped up -- with many of them disrupting the large incumbents. Nevertheless, as CEO Nikesh Arora has pointed out before, cybersecurity customers have begun to express interest in consolidating their vendors to simplify operations.

Thus, Palo Alto has been on a mission to expand its offerings to become a one-stop shop, all while upgrading its legacy hardware-based firewall business. Arora introduced the 2020 first quarter (three months ended Oct. 31, 2019) by talking about his company's progress in cloud security and adding artificial intelligence (AI) and machine learning (ML) to the mix to boost its security automation know-how. Acquisitions have been key, and another one was coincidentally announced with the first quarter report: Aporeto, an identity-based cloud security company, for $150 million. It's Palo Alto's eighth prize in two years.

Company Acquisition Amount Company Description
Aporeto $150 million Identity-based cloud security
Zingbox $75 million Internet of Things (IoT) security
PureSec Not disclosed Announced along with Twistlock, PureSec enables serverless application building and security
Twistlock $410 million Cloud-based application security and management
Demisto $560 million Security orchestration, automation, and response services -- or SOAR in industry parlance
RedLock $173 million Cloud computing security services
Secdo Unconfirmed for $100 million Endpoint security and threat visualization $300 million Cloud computing infrastructure security and services

Data source: Palo Alto Networks and Crunchbase.

Let the numbers do the talking

In two years' time, Palo Alto has spent at least $1.7 billion on its shopping spree. That investment helped the company grow 28% last year with a total revenue haul of $2.9 billion. Adjusted earnings per share grew 30% to $5.45.

That pace was forecast to slow down to the 20% range over the next few years, and that was the case in this latest report. First-quarter revenue grew 18% year over year to $772 million, and Arora and the management team reiterated full-year guidance for 19% to 20% top-line growth for 2020, which pegs revenue at $3.44 billion to $3.48 billion -- not too shabby.

With guidance coming in as expected, it was the bottom line that had some feeling glum, though. Excluding the $150 million paid for Aporeto, adjusted earnings per share are expected to fall this fiscal year to $5.00 to $5.10, a 6% to 8% decline. As Arora put it: "This fiscal year is our year of investment in transformation. We're not looking to cut costs, we're looking to invest."

Though some aren't super excited about that outlook, shares of the cybersecurity leader are still up about 50% since the start of 2018. Growth is still underway, and better than the industry average, in large thanks to the investment in transformative security start-ups. Trading at 22 times trailing 12-month free cash flow (money left after operating and capital expenses), Palo Alto Networks stock still looks like a buy to me.

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Nicholas Rossolillo owns shares of Palo Alto Networks. The Motley Fool owns shares of and recommends Palo Alto Networks. The Motley Fool has a disclosure policy.

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

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