Palo Alto Networks: Assessing future prospects
I bought Palo Alto earlier this year. Since then it’s up 31% vs 13% for the QQQ since my first purchase. I've averaged up twice since and my total position is up 17%. Today I sold out of my entire position.
Why did I make this investment/trade?
I bought Palo Alto as an 'invest and investigate' on February 21 after it crashed 25% following earnings. The reason for the drop was a strategic shift to creating a cyber security platform. This entailed shifting the business strategy around future ARR and RPO (remaining performance obligations - i.e future revenue) over current billings, which was the metric that management had previously guided to. Management stated that clients were showcasing vendor and sector fatigue and preferred a one stop shop - i.e a platform.
What made me bullish?
It seems clear that there needs to be a cyber security platform/aggregator. $PANW is a great candidate for this as a market leader.
Management is strategically foregoing current billings for a longer term shift to ARR. They're keeping clients happy by letting them spread out billings over time, and giving discounts on shifting over. This is a classic example of long term profits over short term profits.
We've seen similar pivots in Adobe, SalesForce and Workday - all great companies that experienced short term pain on the path to long term healthy models.
After a 25% selloff it looked like the market was discounting management and their strategy completely despite years of quality execution.
Over the past two quarters results and forecast for FY 2025 have laid a lot of the bearish fears to rest. Mostly that this talk of 'platformization' is hiding competitive pressure and lackluster execution (there's a good coverage of this here). Palo Alto delivered good quarterly and year end results, matching/narrowly beating forecasts and providing a decent growth story for coming years:
13-14% revenue growth
37-38% free cash flow margin
ARR grew 43% to $4.2B
It seems like the core growth story is still intact. However now that the stock has run 31%, the question becomes - is this priced in and does this justify a long term hold?
Future prospects
I believe in $PANW platform play. No CISO wants to vet, negotiate and buy from 15 vendors. I believe that management is doing the right thing taking a short term hit to billings ot increase ARR and RPO. But at current valuations it's a question of:
Will a platform lead to accelerating revenue growth, higher cash flow or earnings power?
Is this the right position for me to hold in the current context of my portfolio?
For reference, PANW is currently trading at:
12x 2025E revenue
55x 2025E EPS
31x 2025E FCF
This is more richly priced than a lot of other tech companies, with slowing revenue growth over the past few years. They need accelerating growth to grow into these metrics.
Regarding the first question, I just don't know. I don’t have any edge in this space or deep knowledge in the cyber security space. While ARR growing 43% is fantastic, there's a large gap from $4.2B in ARR to the company's current $9.2B revenue projection for 2025. It's not a metric that gives color into accelerating revenue. RPO also doesn't provide enough color, as it can be spread out over an unknown time horizon.
This is a multi year gap that the company has to grow into for investors to get some real visibility on whether the platform shift is providing more revenue growth in the future than the current decelerating revenue growth Palo Alto Networks has been experiencing over the past few years.
While if I had to make the bet, I'd bet this will be successful. But I don't have to make the bet. I can allocate my cash into a position with better risk/reward, more margin for safety or simply something that interests me more (my eyes do glaze over when it comes to cyber security).
Currently, PANW forms ~3.5% of my overall portfolio, leading me to take my successful trade of the table and redeploy the capital into hopefully better opportunities - where exactly I'll be redeploying will be in my next writeup :)