Hi everyone, and welcome new posters!
As the title says, I just completely sold out of Zscaler. For context, this was a 1.8% position in my portfolio. After working through the latest earnings report I realized that the investment thesis has significantly changed. The signs of this already started showing up in the previous two earnings reports, but this one made it crystal clear:
Zscaler’s Capital Efficiency (CapEx vs FCF) collapsed in Q4 as they reported a huge CapEx spike of $199.8 million, which represents a staggering 22% of revenue for the single quarter. Management tried to pitch this as an “opportunistic” pull-forward of data center infrastructure to secure hardware pricing and brace for AI workloads. That might be true, but if we look at the trend over the last year, this isn’t a one-off anomaly; it’s a steady, multi-quarter deterioration of capital efficiency. Look at how Free Cash Flow (FCF) margins have steadily fallen year-over-year:
- Q2: FCF margin dropped to 20.7% (down from 22.1% YoY)
- Q3: FCF margin dropped to 16.0% (down from 17.6% YoY)
- Q4: FCF margin collapsed to just 6.8% (down from 23.9% YoY)
Again, I am not saying here that increasing Capex as they did is necessarily a bad decision - it might in fact be the right decision for the business to survive and maybe even do well in the future. But one part of my core SaaS thesis for Zscaler relied on the business being asset-light with high operating leverage. Zscaler is starting to look like a heavy infrastructure company just to keep its platform relevant.
This by itself wouldn’t necessarily be a deal-breaker for me, but combining this with the growing disconnect between CapEx and slowing ARR growth/revenue growth is what ultimately made me sell this position for now. If management truly believed these huge upfront hardware outlays would fuel hyper-growth, it should show up in the forward guidance. It didn’t: For FY27, management guided for just 16.6% to 17.4% YoY ARR growth. Compare that to their initial FY26 ARR guidance, which sat at 22.7%.
So, we are being forced to accept much heavier capital requirements and lower cash flow margins for a business whose top-line growth is rapidly decelerating. Even just looking one quarter ahead, I am now penciling in that YoY revenue growth will decelerate to 22%, from 24% in the just reported Q4 (mid-point Q1 revenue guide was just for 18.9%).
Digging into the backlog also reveals something interesting: While current RPO growth held steady at 24.7% YoY (even up slightly from 24.4% last quarter), Total RPO growth has now decelerated for three consecutive quarters. Total RPO YoY growth has fallen from 34.5% in Q1 to 27.4% in Q4. When total RPO drops faster than cRPO, it means customers are still renewing short-term, but they are increasingly pushing back on signing large, multi-year expansion contracts.
I don’t like seeing a premium SaaS company transition into a capital-heavy defensive game when growth decelerates from 25% to likely ~20% for the upcoming FY, while CapEx climbs exponentially and long-term customer commitments slow down. With that there is a good chance that the unit economics might be fundamentally broken. I say “might”, because I can also see a bull-case where everything works out wonderfully with the increasing demand for security in a world of ever evolving AI threats. But as my friend @stocknovice likes to say, we are trying to make 60-40 bets with our investments and right now Zscaler feels more like 40-60 to me.
So, I chose to put the capital elsewhere. Where, you might ask? I split the proceeds between Astera Labs and Axon. Both had outstanding earnings reports as you can read here and here and I feel my higher confidence positions already have high enough portfolio allocations. I will say that both Astera Labs and Axon aren’t free of risk either:
For example, one thing that bothers me with Axon is management’s goal to build a flashy, sci-fi-inspired $1.3b headquarters campus in Scottsdale, which I think is completely unreasonable. I mean, does a public safety tech company really need to develop over a thousand residential apartments and a hotel as part of its corporate footprint? It feels like a distraction and an unnecessary use of capital when they should just focus on their core business. Yet, the rest of the Axon story is just too good to not invest in. Despite the real estate distractions, the underlying business is essentially a hyper-growth software powerhouse disguised as a hardware company. They have locked down a near-monopoly on law enforcement technology, and their transition into high-margin cloud ecosystem subscriptions has given them an incredibly sticky high-growth revenue model that is very difficult for competitors to disrupt.
As for Astera Labs, I am a bit concerned about long-term visibility of the business fundamentals because things in the AI infrastructure world can change quickly and hardware standards are constantly in flux. While their execution right now is flawless; evidenced by Q2 revenue hitting $392.4m and my projected Q3 acceleration to 156% YoY growth when assuming a typical 7.5% execution beat - their revenue relies heavily on preventing data bottlenecks between other companies’ chips. In the AI hardware landscape, if a major hyperscaler customer shifts from PCIe architectures to proprietary optical fabrics, or decides to vertically integrate connectivity directly into their next-generation custom silicon, Astera’s hyper-growth could face sudden headwinds. This underlying structural risk might be exactly why the stock hasn’t moved up an inch in the weeks after their mind-blowing earnings print and next quarter outlook; I think the market is seeing huge near-term growth numbers but treats the long-term durability of that revenue with a healthy dose of skepticism.
So back to Zscaler, I’d love to hear if anyone else is seeing these same red flags in the backlog, Capex investments and/or growth deceleration, or if you are choosing to trust management’s long-term AI thesis and why. And happy to hear anyone’s thoughts on Axon or Astera as well!
Best,
Ben