ZS Analyst Day

Investment Analysis Clubs Saul’s Investing Discussions
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The annual conference and Analyst Day presentations were fantastic. For the following YouTube link is active and don’t know if it will stay up. The presentation begins at the 40:55 point. Its worth watching in its entirety. The link is below.

https://www.youtube.com/watch?v=NjvGft0loso

They emphasize they are in stream of company data that co-location of Data Centers is key to low latency with their service delivery.

The ZScaler Digital Experience monitoring (“ZDX”)is key new service that is going into Beta with some key customers and will be available in Q2 2020. (I need to confirm what that is in calendar quarter) This is an amazing service. They can analyze down to the specific device. However, while they can identify the resolution needs to be addressed by other company products. See 1:10:23 Blue Print for Cloud and Mobile World.

Large Addressable TAM 1:13:15

My recommendation is to take an hour and a half and watch this presentation, again start at 40:55

I would appreciate hearing your feedback from this valuable Analyst Day. I watched the conference as well so close to 5 hours of viewing. Not sure the conference will be available other than live.

Commway

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Secure Access Services Edge (“SASE”)

This is a new Cloud stack as defined by Gartner Group and was introduced at the Analyst Day Sept 17, 2019, by Manoj Apte Chief Strategy Officer at Zscaler Inc. If you go to Manoj Apte’s Linkedin account ZScaler has purchased reprint rights for the recent Gartner report The Future of Network Security Is in the Cloud; 30 August 2019; Lawrence Orans, Joe Skorupa, Neil MacDonald.

https://www.linkedin.com/pulse/new-from-gartner-research-fut… Must be a Linkedin member - {free when I signed up}

There is a good writeup on SASE at Manoj’s page on this as well as the download paper.

The whole cloud security talk begins at 41:06
https://www.youtube.com/watch?v=NjvGft0loso

The SASE talk starts at around 49:06

I am really hoping the Saul’s Investing Discussions Zscaler, followers will watch and respond to this YouTube presentation. For me, this is the most detailed information I have seen and heard on ZS. Where it plays in the Cloud market place, who its competitors are, who it can work with. New products Zscaler B2B and Zscaler Digital Experience this later product seems to me to compete with DDOG monitoring services. This was introduced yesterday during the ZenithLive annual conference.

Hoping to hear from you all,
Commway

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commway,

Thanks for posting the link. I listened for 20 minutes and frankly found it over my head; too much technospeak for the two neurons still working. I am not a data analyst, programer, or security nug. I appreciate all the translations that appear here.

Thanks,
Gordon

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I did find interesting, however, that the CEO said 25 Percent of all traffic going through ZS ois office 365.

Gordon

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Please disregard my first comment. Later in the briefing is a detailed discussion of the company’s financials, goals and future growth prospects. New go-to-market chief, Dali Rajic, talks about growing the land and expand model - not sure how that will happen. He still has not started, but of course is making himself familiar with the company.

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Large Addressable TAM 1:13:15

Did they talk about any near-term revenue growth goals? I haven’t yet looked into their analyst day materials.

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Jay was cautious about getting tagged with a TAM number. “numbers will be significant”. The ZB2B, and (“ZDX”)Zscaler Digital Experience are going beta in coming weeks and should begin to introduce new revenue streams in 6 months or so, Q2 2020, on allowing security and control for contractors or supply chain to interact with security and control, details are further along.

The ZDX is full monitoring of performance with being able to target ZS issues resolved with proxy revisions or identifying specific devices needing resolution. The resolutions will be handled by System Integrators or other cloud tools. These options make supporting bottom-up support lucrative for SI or competition to support ZS use. Also, Microsoft was effuse of ZS for its simple and complete integration with ZS. The low latency of proxy with 150 Datacenters means local support and when different GEO areas are in play for international accounts it’s like being in the same building - this was from today’s Microsoft presentation at ZenithLive. The Analyst Day is covered by forward-looking statements so don’t book numbers immediately.

This Analyst Day material is the deepest and broadest information available to us investors. I am not qualified to compare Cloud offerings but if anyone out there is, it would be great to get feedback. I feel very confident with my ZS investment although new offerings and solid earning reports still necessary to offset my late entry in mid August.

Commway

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I feel very confident with my ZS investment although new offerings and solid earning reports still necessary to offset my late entry in mid August.

Watch out for the revenue growth. I think ZS story is not a simple story to sell and it is going to take a longer lead time and that means the revenue growth could get to 25% to 35% and that is something market may not like it. I don’t know about the long-term clearly the next few quarters the revenue growth is going to be volatile.

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Watch out for the revenue growth. I think ZS story is not a simple story to sell and it is going to take a longer lead time and that means the revenue growth could get to 25% to 35% and that is something market may not like it. I don’t know about the long-term clearly the next few quarters the revenue growth is going to be volatile.

“Think” “means” “not like” “going to be”.
Absolute statements carefully phrased to seem like fact still do not make it so.

  1. “Watch out for revenue growth.”

You should already be doing that every ER. Agreed.

  1. “I think ZS is not a simple story to sell and it is going to take a longer lead time and that means the revenue growth could get to 25% to 35% and that is something market may not like it.”

Yet their success up to this point, selling the exact same solution has been done at stellar growth rates. The longer lead times refers to larger Enterprise clients (think Fortune 25-50) which also have bigger payouts once landed. It does not mean that all their sales cycles will suddenly, inexplicably, become longer. There is nothing in past several Q’s to suggest a 25-35% actual revenue growth rate will occur in any of the next 4 Q’s. ZS mgmt has repeatedly sandbagged guidance more aggressively than most, and go out of their way on the CC to state “We like to be prudent with our guidance and our guidance we feel is prudent.” Simply reading the CC transcript or listening to the reply makes this very apparent. I encourage you to listen or read the CC for all previous ERs. At beginning of FY19, they forecasted 36% growth, and finished at 59% actual. For FY20, they just forecasted 33%, and (my opinion only) I think it is reasonable based on past guidance beats to assume their revenue will finish FY20 close to 50% y/y. Finally, the newly hired CRO should pay dividends in 2H-20, which was also stated on the CC.

  1. “I don’t know about the long-term clearly the next few quarters the revenue growth is going to be volatile.”

Actually, there is no reason that it would be clear to expect volatility in the growth rate. Likely they grow +/- a few percentage points each Q from 50%, based on history. Anything else is just pure speculation.

Dreamer ← enjoying the ride up from $46.

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Funny thing is, Zscaler hit my revenue number that I predicted last year at $305 million. For 2020 I have forecasted (to support my future expectations) they will do $450 million. They have guided for $405 million at the top of their guidance. They only need to beat that guidance by 11% equal that number. Hardly disappointing guidance.

Palo Alto did grow faster. As I said I did a detailed historical analysis. Their growth slowed into the $50s shortly after going public and actually fell into the high 40s for one quarter. For guidance one quarter they gave guidance for 35-40%. Probably about the time Palo Alto fell by 43% from its then high. Hmmm, seems very de ja vuish.

One thing that Zscaler has that Palo Alto had very little of is that Zscaler has grown value per customer each year by a substantial amount (although growing new customers slower than Palo Alto). To date Palo Alto is still barely growing its revenue per customer (at least through 2016 when I ended my analysis).

Give some, take some. At this point in time there is not a single serious competitor in the world doing what Zscaler is doing. If they do, please name it.

Also, would be nice to find an example when a technology platform has changed that puts the incumbents into an innovator’s dilemma, who after trying to minimize their losses to the new paradigm (such as Palo Alto is trying to do by promoting continuing the current paradigm while bolting on cloud use for SD-WAN and on the edge where appliances won’t fit anyways) that then comes back to dominate the new paradigm after the disruptor has already gone on to lead the pack for years?

Cisco could not even stop Arista. Cisco only started mitigating Arista after the 100 gb/sec tornado (Such as it was) faded and the cloud titans slowed their demand. What Palo Alto has to do is either enable appliances forever as the architecture, or figure out how to survive someday as a business when NGFW die away, such as this article (one of several over the last few years) is quite confident of: https://www.anitian.com/the-ngfw-is-dead/

Arista had similar articles around its disruption of Cisco in its early years as well as they transformed their portion of the network into software defined bare metal from proprietary and expensive silicon that Cisco is built on.

Palo Alto had stories like that about the NGFW (nearly identical to the article I linked to above - but about NGFW and not cloud security - stating NGFW is starting to gain early acceptance but it will still be years until it puts to rest the existing security paradigm of the time that was lead by Cisco and the like. Yet somehow they “did not catch up” by the look of Palo’s cash flows.

You can practically just substitute in Cloud security for NGFW and barely change a word in the articles except for the names of the companies.

I do have concerns about revenues from quarter to quarter as we all do as we sit with bated breath at each earnings call. However, the success of this new paradigm will be as complete as the success of NGFW that barely existed in 2010. Please review the article.

Palo Alto lead that technology revolution. Zscaler is leading this one with Palo Alto the incumbent this time, as was Cisco for Palio Alto back then (Cisco, hardly a patsy).

No, nothing is guaranteed except that when one makes a conclusion such as “competition will quickly catch up” one should support it with some facts or reasons as to why. That is a discussion. Otherwise all it is, is blatant speculation (not informed speculation - which is very welcome).

Tinker

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There is nothing in past several Q’s to suggest a 25-35% actual revenue growth rate will occur in any of the next 4 Q’s

The analyst community, which is bullish on the name BTW, is forecasting $400M for fiscal 2020 and $500m for fiscal 2021, that from 2019 exit rate of $302m, means 35% growth and 25% growth on 2021.

Of course all the analysts can be wrong and the company can surprise.

It does not mean that all their sales cycles will suddenly, inexplicably, become longer

Find below management’s comment and Q&A from the recent earnings.

We’re not sure if the macroeconomic environment is having an impact, but we started to see some large deals taking longer to close.

Brad Zelnick

Hello. Excellent. Congrats on a fantastic year and it’s excellent, excellent. So, congrats on a fantastic year and it’s great to see your sustained growth above 50% if we make the proper adjustments. Jay, I wanted to ask you about your comment about large deals taking longer to close. What are the proof points that suggest to you that this may be due to macro deterioration versus perhaps execution issues? And what gives you the confidence this isn’t a change in the competitive dynamic for what you’re selling?

Jay Chaudhry

Yes. So, we deal with a large number of deals. Our pipeline has been growing. The comment we made was that some of the larger deals took longer. Talking about macro versus competition, I can tell you that if we analyze our Top 50 deals which we did, we really see any competitive, real competition from firewall guys or other guys. So, our competitive rate remains very, very strong.

On the macro level, we haven’t seen any significant things to really say that macro is playing a role in it. We do believe that as the large number of reps are being hired, they all need to go through a bit more sophisticated sales methodologies, sales framework and the like, so we can keep on scaling the successful execution we have been doing so far, so not worried about any competitive pressures. No clear indications on the macro though that kind of remains to be seen as everyone does talk about them, but we are excited that we have a new CRO who can help us further scale the kind of work we’ve done before to the next level.

Nick Yako

Thanks guys. Jay, you mentioned seeing more customers adopt both ZIA and ZPA out of the gate, which is great. So I guess, I’m just wondering if that’s having an outside impact on the sale cycles?

Jay Chaudhry

So yes, bigger the products that you buy typically longer the sale cycle; or if you want to talk about general, the bigger your deal the longer the cell cycle, but I think our mix has to be – a mix is not really I won’t say that all mostly deals are becoming combined ZIA, ZPA, the transformation sale in general is complex. It’s top down. You end up securing the support of not just head of network, head of security, head of architecture, so we have a large number of people who can do it well, but we need to grow that type of sales team along with some of the architects and all to really make sure we are effectively selling it

My comment: If you read them all together, the deals are complex, it takes time for the sales persons to ramp up, the sales involves buy in from the top down. When a buying decision requires buy-in from many departments, it will take time, will take more educating, etc. If you can appreciate the challenges in a bigger organization in adopting something that is not incremental but completely transformative, then it is easier for you to see why the sales cycles are going to be longer.

Likely they grow +/- a few percentage points each Q from 50%, based on history. Anything else is just pure speculation.

Just saying, your opinion, even if based on history, is still a speculation. For every buyer there is a seller.

Good luck.

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Also, would be nice to find an example when a technology platform has changed that puts the incumbents into an innovator’s dilemma, who after trying to minimize their losses to the new paradigm (such as Palo Alto is trying to do by promoting continuing the current paradigm while bolting on cloud use for SD-WAN and on the edge where appliances won’t fit anyways) that then comes back to dominate the new paradigm after the disruptor has already gone on to lead the pack for years?

If you are saying the “first mover advantage is so strong”, and the existing player who is worried about cannibalizing their revenue, never able to get back in the game, that is a fair point. But, for that most important thing is, the platform shift has to be super compulsive and the platform adoption should be pervasive and fast.

At this time, all 3 are its infancy and needs to be seen.

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I agree, it needs to be seen. But that is growth investing. I went 50% into SHOP at one time and yet it was still to be seen if it would dominate. Always a risk/reward but sometimes you just know (and even those times, rare as they may seem, you will get it wrong). I do not invest so that I can invest in Amazon today instead of 10 years ago, as an example. Not like a WalMart was ever up my investment alley but if one could see it was dominating as it was one does not wait until it pays dividends to invest because then it is a sure thing.

I think it is a sure thing that the NGFW will become a distinct minority platform 10 years from now. Cloud will replace it almost everywhere. The leader in that movement with no direct competition (lots of legacy competition, some smaller players doing sort of what Zscaler does - Zscaler already bought one of these for their alternative technology) is Zscaler.

Thus, if NGFW is to disappear as did the prior platform, and Zscaler is the dominant purveyor of what will eventually replace it, it is likely Zscaler will do very well. Hey, AOL bought Time Warner but the switch from dial up to broadband killed AOL in a matter of months. So anything can happen. Who knows what else disruptive may come along.

If you are a growth investor Zscaler is on that list as a disruptor just as Okta, SHOP, Amazon, Google, AYX, Mongo et al are. No one has caught up with AYX yet, nor OKTA nor SHOP (Amazon gave up). Mongo was one we invested in on NPI more than a year ago. SHOP more than 2 years ago. Some have fallen away like Pure (but I never held it due to the rules and reasons I often discuss, same with Talent for the same reason. I did get caught with Nutanix. It did not meet my rules per se, but for one quarter it became the #1 purveyor of its product in what looked like a duopoly. I had a 50% profit on it that fell quickly to break even - what you gonna do. Turns out DELL was materially important for Nutanix. When DELL turned, Nutanix fell quickly). With Zscaler Office 365 is tremendously important - that needs to be understood.

Tinker

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I think it is a sure thing that the NGFW will become a distinct minority platform 10 years from now

I assume you mean “Next Gen firewall implemented via appliances”. An interesting solution could be, today various load balancers have the ability to act as SSL terminators, so, on-premise appliances can add additional modules to handle unpacking SSL traffic, inspect and then direct it. The technology exists and it just needs to be integrated with the firewall’s. Not impossible.

The leader in that movement with no direct competition (lots of legacy competition, some smaller players doing sort of what Zscaler does - Zscaler already bought one of these for their alternative technology) is Zscaler.
I know you don’t consider Prisma and cortex as competitors, but today those products have market acceptance. Also, if stock market god’s willing PANW or some other legacy player may get an opportunity to own OKTA or CRWD and suddenly they can outflank ZS from all sides.

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Tinker, you are getting to the heart of it. I sense from your prose that you have some understanding of this networking world. There is a great deal of material in the entire Analyst Day link, with your knowledge and discernment I believe you could greatly clarify for us the next steps and barriers to success.

Some good news I looked at the ZScaler YouTube page and found today’s Microsoft Presentation, it should help you further understand the working relationship between MS &. ZS. Here is the link

https://www.youtube.com/watch?v=aTZ3Wz_EaCs

starts at 37:06 to 1:12:00 35 minutes pure gold. The Microsoft lead ends with this quote (not word for word you can catch at the end it’s not marketing integration but project integration and a real partnership

More great news here is the link to the ZS Analyst Day slide PDF document 74 pages!
https://ir.zscaler.com/static-files/bcbf2456-f86a-43e9-adf2-…

Commway

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Thanks especially to Kingran, Dreamer, and Tinker for some thought provoking and intelligent recent discussion on Zscaler. I have built my position back to almost 18% but I’m glad to have had some some devil’s advocate points of view too to keep our thinking balanced.
Best,
Saul

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I listened to most of the conf. I liked the way they explained the following:

  1. How they are not competing with Okta - at airport Okta is like the database that checks your passport and see if you are allowed to travel to country X. ZS is like the ticket agent who makes it possible
  2. How they are not competing with APMs like NEWR. ZS can tell where the bottlenecks are but NEWR resides in the app and can tell what is wrong with the app.
  3. Their description on why NGFW hybrid cloud approaches leads to severe latency and performance issues.

They seem to really understand what they are doing. The founder CEO has spent a career in security, has sold legacy boxes and understands the issues. He can explain complex things unlike the Nutanix CEO. There was an oilwell CTO who spoke how ZS has helped reduce costs and improve user experience. It looked like he really wanted to be there. They just signed a 3 year extension. The sales issue boils down to this simply - they expected to close more deals last Q. Competition was not the reason. they cannot say it is macro as it is a single data point and not a trend. As Jay was explaining the new CRO Dali interestingly jumped in and said it was likely because a unified sales system that sets the best practices for the organization did not exist. That is what is needed for a large 1B company. Remember this is still a small company.

I felt quite confident after all this and bought a bunch today and it is now at 16% of my port! Noticed that it has dropped 5% today so have CRWD. Related to DDOG IPO? Cant say.

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Thanks for the link Commway, and the discussions. I really enjoyed the National Oilwell Varcoe CIO talk about their ZS journey (about 2h:14m in).

There was a couple of analyst questions which I thought were really interesting (re costs) - my transcript below.

The takeaway I got was he really doesn’t want to think that much about security. Doesn’t want to support boxes, and importantly doesn’t want his users to suffer a degraded experience (he talked about an exec stating that (the execs) experience with a dialup modem back in the day was better than what the exec got now).

cheers
Greg

Q: Costs for ZS journey…?
A: “Was no capexp. Moving to ZS eliminated $2m capex cos needed to replace old appliances. Opex - displaced 3 vendors for me, ZS cost opex cheaper than combined OPEX for those 3 vendors. To me cost optimisation move. Adding ZPA - not a cost savings move, it was a security move and an employee experience move, and so that was an add. Recently resigned for another 3 years.”

Q: Last time we spoke, you were thinking about, taking a closer look at your firewall footprint in your branch offices, specifically getting rid of them. Assuming thats been done so far, what did you replace that with, just ZS, or any other hardware?
A: My goal every single facility has an internet site. I want the stupidest box I can put at a facility to route the traffic to the cloud where it can be protected. In 3 years time, I have not had to worry about patching, oh this appliance is the wrong size, omg this firmware is blocking something or not working right. ZS has done multiple upgrades and it’s just worked seamlessly.

When I look at my branches, we’re on the journey to giving internet to them, we’re seeing about a 4x savings vs MPLS, going with cheap white-box solution and putting a SD-WAN piece of software on there. I’d love to eliminate that at some point. I’d love to say, “Hey ZS heres all my traffic, route it where it needs to go”

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Couple other things I found of interest.

  1. ZS is mainly a large enterprise company. They are at 400 of the G2000 companies. Avg ACV for G2000 is $437K. Last Q they found that deal sizes with ACV were growing faster than the >$500K. Hence Jay’s comment. My calcs shows that they get about 2/3 rd rev from Global 2000. Office365 is 25% of traffic. Lot of G2000 customers still have not implemented Office. So still runway. But I am curious what is a sustainable level of that traffic. Is it 50%?
  2. Around the 3:55 mark while responding to a question Amit Sinha discusses why an appliance maker with cloud proxy can never attain equal perf. GCP has only 20 regions and 6.7 front doors. No compute at front doors. ZS DCs offer computing and you need that for SSL inspection. So PANW claim of 100 locations are just front doors. They have to be sent to a Google or Azure or AWS datacenter and then hairpin back. There is also mention of architecture issues on how ZS was built from the start in a certain way as opposed to a firewall. Worth a listen. Also Amit Sinha’s earlier presentation where he goes more in depth.
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1. ZS is mainly a large enterprise company. They are at 400 of the G2000 companies. Avg ACV for G2000 is $437K. Last Q they found that deal sizes with ACV were growing faster than the >$500K. Hence Jay’s comment. My calcs shows that they get about 2/3 rd rev from Global 2000. Office365 is 25% of traffic. Lot of G2000 customers still have not implemented Office. So still runway. But I am curious what is a sustainable level of that traffic. Is it 50%?

Looked at in “S” curve terms – very much in back of the envelope terms. The table below shows why SaaS stocks have seemingly absurd valuations, a compounding of account growth and per account revenue.

The table below has five scenarios by ZS market share. My conservative estimate is 60% market share.

The top table estimates current market penetration. All are above 15% so ZS is in fast growth mode.

The middle table estimates how many of the G 2000 accounts ZS can grab as a function of market share and 85% market penetration.

The next table estimates the five year revenue growth based on the effective dollar retention rate. This assumes that 85% market penetration is achieved in five years.

The last table shows the $ retention rate in terms of CAGR. I highlighted 50% CARG in each column.


**ZS market share             50%     60%     70%     80%     90%**
G 2000                    2,000   2,000   2,000   2,000   2,000
ZS accounts                 400     400     400     400     400
Competitor accounts         400     266     171     100      44
Market penetration          800     666     571     500     444
Market penetration %        40%     33%     29%     25%     22%

Top of “S: curve            85%     85%     85%     85%     85%
85% market penetration    1,700   1,700   1,700   1,700   1,700
Remaining to reach 85%      900   1,034   1,129   1,200   1,256
ZS share                    450     620     790     960   1,130
Account expansion          113%    155%    198%    240%    283%

**Effective $ retention rate =------ Growth after 5 years ------=**
110%                       181%    250%    318%    387%    455%
120%                       280%    386%    492%    597%    703%
130%                       418%    576%    734%    891%  1,049%
140%                       605%    834%  1,063%  1,291%  1,520%
150%                       854%  1,178%  1,500%  1,823%  2,146%
**CAGR**
110%                        13%     20%     26%     31%     35%
120%                        23%     31%     38%     43%     **48%**
130%                        33%     42%     **49%**     **55%**     60%
140%                        43%     **53%**     60%     67%     72%
150%                        **54%**     64%     72%     79%     85%

At 85% market penetration fast growth necessarily slows but by then these companies are fantastic cash cows. There is no reason why Effective $ retention rate must also slow.

Is it any wonder that account growth coupled with revenue growth per account ($ retention rate) creates a gold rush? But, in my estimation, this growth will happen over a relatively short time span, measured in years, not decades.

So, yes, growth will slow, valuations will compress, but not before one hell of a gold rush drive!

Denny Schlesinger

PS: Please point out any bugs in my calculations, back of envelope are error prone. :wink:

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