PANW earnings out and not loved by the market

Investment Analysis Clubs Saul’s Investing Discussions
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So I put out a summary to Palo Alto’s earnings on the stock board and thought I would add it here as well. For those interested here, note that the cloud based cyber security business reported 47% growth even after talking about going to a freemium model. A small decrease from last quarters 50% growth. It will be interesting to see if CRWD or ZS can keep up even while PANW has the largest overall ARR base. Anyway, here it is…

Highlights:

  • Fiscal third quarter revenue grew 15% year over year to $2.0 billion
  • Remaining performance obligation grew 23% year over year to $11.3 billion
  • Non-GAAP operating margin grew 200 bps year over year to 26%

“We are pleased with the enthusiastic response to platformization from our customers in Q3. Platformization is a long-term strategy that addresses the increasing sophistication and volume of threats, and the need for AI-infused security outcomes,” said Nikesh Arora, chairman and CEO of Palo Alto Networks.

“We have remained disciplined in our execution while investing in go-to-market and innovation,” said Dipak Golechha, chief financial officer of Palo Alto Networks. “We delivered consistent, profitable growth yet again in Q3 and look forward to executing against our strategic goals and financial targets as we close out the year.”

Guidance:

  • Total billings in the range of $3.43 billion to $3.48 billion, representing year-over-year growth of between 9% and 10%.
  • Total revenue in the range of $2.15 billion to $2.17 billion, representing year-over-year growth of between 10% and 11%.
  • Diluted non-GAAP net income per share in the range of $1.40 to $1.42, using 345 million to 347 million shares outstanding.

For the fiscal year 2024, we are updating guidance and expect:

  • Total billings in the range of $10.13 billion to $10.18 billion, representing year-over-year growth of between 10% and 11%.
  • Total revenue in the range of $7.99 billion to $8.01 billion, representing year-over-year growth of 16%.
  • Non-GAAP operating margin in the range of 26.8% to 27.0%.
  • Diluted non-GAAP net income per share in the range of $5.56 to $5.58, using 343 million to 344 million shares outstanding.
  • Adjusted free cash flow margin in the range of 38.5% to 39.0%.

So it appears that the markets didn’t like the quarterly report. This time because billings increase were low. Nikesh is claiming that is not the important number as it is affected by the companies choice of whether the client has long term account or pays upfront. I am not sure I totally understand all of that. But I will say that the ARR of the nextgen cloud based revenue was up a very nice 47% to a $3.79 B and Nikesh is pushing to be the first company with an ARR of $5B by 2025. And operating margins improved again. Also, two major deals were highlighted with the addition of United Health Care and IBM.

The numbers look pretty good to me. The platformization that they are pushing as important to future business and improving operation margins seems to be working but the market doesn’t seem to like it, at least overnight.

Finally, Nikesh Arora appeared on Mad Money yesterday evening ( May 20th) which you can listen to on the Mad Money podcast to explain the earnings release. The conversation is interesting and worth your time if you own this stock or and thinking about doing so.

Here is a link to the release: https://investors.paloaltonetworks.com/news-releases/news-release-details/palo-alto-networks-reports-fiscal-third-quarter-2024-financial

And here is a link to the presentation which always does a nice job of highlighting where they are going and breaks out various performance factors:
https://investors.paloaltonetworks.com/static-files/bc03bef2-80a1-462e-a8ab-ae06ec1d7839

Randy
Long PANW and Tickerguide

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Hi Vince. Not sure where you got your revenue numbers. The quoted ‘24 revenue estimate is $8B, with a market cap of $100 B, the price/ sales is 12.5. Non-GAAP earnings estimate of $5.80 gives roughly a 50x PE. Now I agree the PE isn’t really cheap but given the growth and margin expansion they have delivered over a long time, it doesn’t seem unreasonable in my opinion.

Yes, share expansion is a problem for all of these cyber growth companies. It seems like it is tough to get away from that without skipping the industry entirely as an investment.

Randy

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My bad - post deleted… sorry

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So all the results are in from Palo Alto (growing 15%), Zscaler (growing 32%), Crowdstrike (growing 33%) and SentinelOne (growing 40%).

I’m looking forward to the cyber security sector comparison that gets shared on the board but it is shaping up into an interesting scale and speed set up.

Effectively Crowdstrike is 50% the scale of Palo Alto on revenue and billings terms but growing 2x Palo Alto and roughly the same in terms of NGS ARR (the one metric Palo Alto beats Crowdstrike on growing at 47%)

Zscaler is 25% the scale of Palo Alto on revenue and billing but growing 2x Palo Alto and roughly 50% the size of NGS ARR.

SentinelOne is 10% the scale of Palo Alto on revenue and billings and growing 2.5x Palo Alto and about 25% the size of NGS ARR of Palo Alto.

Palo Alto whilst still the leader in terms of scale, sees growth lagging its peers in all metrics: Revenues, Billings, Customer Accounts and RPO except NGS ARR.

At the same time ZS and Crowdstrike are ramping up Non GAAP profitability and now reaching GAAP profitability and growing free cash flow generation with even SentinelOne reaching Non GAAP breakeven.

It’s an interesting juncture with Palo Alto witnessing spending fatigue in the face of its platformisation narrative and its peers still maintaining healthy growth rates.

Intrigued to see if the acquisition rumours surrounding Zscaler come to pass.

Ant

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Ant,
Thanks for your thoughts and analysis. ZS is my largest position as I feel they are the most undervalued. CRWD is an execution machine but it’s pretty richly valued. I have been trimming CRWD. Both are now generating massive amounts of cash and are growing at scale.

For valuation purposes, I look at PS and also P/CFFO. Prior to CRWD earnings (I haven’t update numbers yet): CRWD is PS at mid-guidance was 18.8, and ZS was 12. CRWD P/CCFO is 63 whereas ZS is 35. Growth rates roughly comparable, but CRWD is bigger.

So I am getting more excited about ZS than CRWD.

I’ve never invested in S, because they didn’t generate cash. But they are turning. I feel it is time to revisit whether they may be investable and I’ll be looking at that soon.

For PANW, they are transitioning business/license models. Almost every time I’ve seen hyper growth companies do that, it doesn’t work out. The reported growth rates are always too low and the look-through growth rates always look good, but it just never works out. MDB was in that situation. Also Nutanix. What tends to happen is right around the time that the look-through growth rates become the corporate growth rate, the hyper growth period is over. Basically, I think the look-through growth rate is usually inflated by the transition from old model to new, and once the transition is largely complete the inflation disappears, and the native growth rate is much lower.

So from now on, I invest in only pure plays. If a company has to undergo a business model transition, that is just a more risky situation, why not stick with the pure plays.

Synopsis: Long ZS and accumulating; Long CRWD and trimming; S on Watch List; Avoiding PANW

Thanks,
Rob

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Yeh kinda agree, although I do hold a small slice of SentinelOne alongside my ZS and Crowdstrike positions. I’m ok about spreading my cyber security exposure between:

  1. Different sectors - such as End Point security vs Cloud security
  2. Different S curve growth situations and future potential
  3. Different valuation levels

Cyber security is such a large TAM and rock solid priority for IT spend, I’m good with multiple player exposure.

Ant

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Hi Ant, I will be putting a summary together and I respect all of the opinions I see on here. I also see the concerns with Palo Alto being an amalgam of two companies between the firewalled cyber security and the cloud SAAS business.

But I will say that it seems like you downplayed the company by combining them in terms of revenue. Comparing total revenue increase of Palo Alto to the others is not really fair in my opinion. Comparing apples to apples shows that Palo Alto is doing very well in the cloud business and doesn’t seem to be discussed enough. Their ARR for the next gen software (cloud based) was 47%, which was significantly larger than any of the others and that was based on a larger base. I don’t see any slowdown in this space in terms of market share, in fact their market share is increasing!

Now if you want to talk valuation, I get it. You are buying a combined company. So some advantages and some disadvantages. A slower growth for the firewalled business but the advantages of true platformization. We shall see how that all plays out, but the idea that others are running away in the new space is just quite frankly wrong.

More to come as I do all the numbers but I don’t understand the thought that Palo Alto is either losing out or showing slower growth compared to the others….

Randy
Long CRWD and PANW, and PANW TICKERGUIDE.

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Hi @CMF_BigECat -

I’d be curious to see your write up as well. One thing I’ve never quite been able to wrap my head around with PANW is how much of that ARR is simply a shift from its legacy business to next gen rather than new business. I feel that dynamic played at least a partial role in PANW’s shift in pricing and business model messaging a couple quarters ago.

I could have this totally wrong, but my impression was existing customers basically got tired of paying at or near full freight for both legacy and next gen systems while transitioning between the two. That led to the discounts which in turn led to the billings guide being restated down at the same time ZS was able to issue small raises.

Do I have that right when thinking about PANW’s ARR? If so, how do you weight that when looking at PANW overall?

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Hi Randy - totally looking forward to your summary and believe me I’m not dismissing PANW, I fear them. I used to be a holder back in the day (along with Fortinet) when they were up against CheckPoint but with the arrival of ZS and Crowdstrike and the SaaS cloud oriented security players then I shifted across.

Yes PANW quickly got into that game with a critical acquisition (PRISMA) and vision and investments and represent a massive incumbent threat I totally get that they are growing that portion of the business very fast from within which is why I keep an eye on it. But you can’t invest in just that business only the whole business and as StockNovice says, it is hard to decipher how much of that growth is internal cannibalisation with an easy leg up vs new market opportunity penetration.

At the end of the day the players may all end up in the same place but for now the investment opportunity is with the outright growers rather than Palo Alto that is running to standstill.

Of course the ultimate threat from Palo Alto is whether platformisation is so pervasive a movement that it removes the opportunities for multiple winners and leads to a winner take all scenario. That is the major reason why I follow PANW and why I might consider going back into it.

Ant

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