Palo Alto Networks (NYSE: PANW) ended May on a terrible note. The cybersecurity specialist's fiscal third-quarter performance didn't pass muster -- though the company beat Wall Street's top and bottom-line expectations, its guidance for the current quarter left investors with a bad taste in their mouths.
Analysts were quick to question Palo Alto's growth story, lowering their price targets under the belief that the company's transition to cloud-based services will take longer than expected to deliver tangible results. But I believe that now could be a good time to buy Palo Alto stock after its latest pullback. Here's why.
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The devil in the details
Wall Street took issue with the fact that Palo Alto expects earnings of $1.41 to $1.42 per share for the fourth quarter of fiscal 2019. The market was originally looking for $1.55 per share in earnings from Palo Alto, but its bottom line will be negatively impacted by acquisition costs to the tune of $0.12 per share, as well as a $0.02 per share charge on account of the U.S.-China trade war tariff.
Without these one-time charges, however, Palo Alto's earnings would have been right in line with what analysts were originally looking for. So there's no need to press the panic button yet, as the cybersecurity specialist's problems are only short-term in nature.
However, bears pointed out that the earnings miss wasn't the only reason why investors sold Palo Alto stock in hordes. The company's third-quarter billings increased 13% year over year to almost $822 million, while analysts were originally expecting $872.6 million. But this shouldn't alarm investors either, as Palo Alto attributes the slower-than-anticipated billings growth to shorter contract durations.
According to CFO Kathy Bonanno:
The dollar-weighted contract duration for new subscription and support billings in the quarter remained at approximately three years, but declined by four months year-over-year due to the strength of our cloud business and fewer multi-year deals.
Had Palo Alto's contract duration stayed consistent, the company's billings could have easily beaten Wall Street's expectations -- it lost four months of billings thanks to the shift to the cloud and a subscription-based business model.
As such, Palo Alto's quarterly performance and the accompanying guidance weren't as bad as they looked. More importantly, a closer look at the company's results makes it clear that Palo Alto is pulling the right strings to ensure long-term growth.
Don't miss these positives
Investors shouldn't be fixated on analyst estimates, as there are quite a few metrics that show Palo Alto is making terrific progress in the cybersecurity market.
For instance, the company's customers have increased their spending on its services. The lifetime value of Palo Alto's top 25 customers went up 35% year over year to a minimum of $38.7 million during the quarter.
The customer lifetime value is made up of the revenue generated from a customer after subtracting the money spent to acquire that account. So the substantial increase in the lifetime value of its top customers is a big positive for Palo Alto, as it is not only augmenting the company's top-line growth but also contributing toward fatter margins.
The company's third-quarter gross margin increased 30 basis points year over year, and that figure should keep getting better as Palo Alto expands its range of offerings through acquisitions. That's because new acquisitions will give the company a bigger cross-selling opportunity in the future.
The big picture is still intact
Palo Alto announced two new acquisitions -- Twistlock and PureSec -- that will negatively impact its short-term results.
Twistlock is a container security provider for cloud-native applications that serves more than 290 customers, a quarter of which are Fortune 100 companies. Container security is an emerging sector of the cybersecurity market because developers have been rapidly moving toward app containers.
It is estimated that the app container market will clock an annual growth rate of nearly 33% through 2023, so the Twistlock acquisition should prove to be an asset for Palo Alto in the future. Meanwhile, the PureSec acquisition will help Palo Alto make a dent in the serverless cybersecurity space, which is another fast-growing niche.
As it turns out, the global serverless market is forecast to grow at a compound annual growth rate of 28.6%. So the demand for cybersecurity for serverless applications is all set to increase in the future, and Palo Alto is making a smart move by getting into this vertical.
This is how Palo Alto is securing its long-term growth -- so it doesn't make sense for investors to panic because of the guidance miss.
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