The cybersecurity giant's shift to a new growth strategy looks promising.
Cybersecurity giant stocks Palo Alto Networks (PANW 3.26%) The stock price has recovered in recent weeks, climbing above $300, but not until May 20, when the company reported results for its third quarter, which ended April 30.
Suddenly, Palo Alto Networks shares have plummeted. Could this be a buying opportunity? Or does the drop indicate a reason to avoid the stock?
To answer these questions, we need to take a closer look at Palo Alto Networks to understand where its business stands today, which includes evaluating the company's stock as a long-term investment.
Palo Alto Networks New Growth Initiative
Palo Alto Networks' stock price decline following its recent earnings release can be attributed to the company's fourth-quarter revenue guidance of $2.2 billion, which fell short of Wall Street expectations.
The company's modest fourth-quarter revenue outlook, just above $2 billion compared to the same period last year, comes as it decides to shift to new business strategies, including a plan to offer its Cortex cybersecurity platform for free for a limited period of time.
This is to encourage customers to move away from competitors and consolidate their cybersecurity needs with Palo Alto Networks.
As a result, the company expects fourth-quarter revenue to grow modestly as customers redeem the benefit, which is driving the company's conservative fourth-quarter guidance, but the weak year-over-year sales growth is only a short-term picture.
Customers who opt into the free offer will sign a 3- to 5-year contract that will extend well beyond the free period — just enough time for customers to transition away from their existing cybersecurity vendor — and in the long term, Palo Alto Networks is poised for strong revenue growth.
Why Palo Alto Networks adopted this strategy
Palo Alto Networks adopted the new strategy, which it calls platformization, after executives noticed a trend among customers who once bought a patchwork of cybersecurity products from multiple suppliers but are now consolidating their spending with fewer vendors.
In the midst of this industry consolidation, Palo Alto Networks has taken an aggressive strategy of offering Cortex for free to encourage companies to choose its platform.
Palo Alto Networks is able to generate greater annual recurring revenue (ARR) from customers who adopt its entire platform rather than buying individual products such as firewalls. ARR measures the total revenue the company receives from customer contracts over the course of a year.
Customers who buy Palo Alto Networks' standalone cybersecurity products spend an average of $200,000 in ARR, but customers who adopt any of the company's three platforms have an average ARR of $2 million.
The company's platform strategy was implemented in the second quarter, and results since then have been promising: Palo Alto Networks achieved 65 platform sales in the third quarter, a 40% increase from the second quarter.
And despite lost revenue from free promotions, the company's third-quarter sales rose 15% year over year to $2 billion.
Should I buy or not buy Palo Alto Networks stock?
Palo Alto Networks is so confident in its platformization strategy that it has set a goal of increasing ARR to $15 billion by 2030. This is a significant ARR increase, considering the company expects ARR to reach $4.1 billion in the current fiscal year.
Palo Alto Networks is well positioned to make this happen: Not only do their free promotions motivate customers to switch, but Palo Alto Networks continues to evolve its solutions to keep up with the ever-changing cybersecurity landscape.
On May 7, the company announced new AI-enabled capabilities designed to use AI to thwart cyberthreats, in an effort to counter AI with AI. On May 15, Palo Alto Networks and IBM announced a partnership under which IBM's more than 1,000 consultants will help sell Palo Alto Networks' cybersecurity solutions.
Palo Alto Networks is also in strong financial position. Third-quarter net income was $278.8 million, more than double the $107.8 million reported a year ago. The company's balance sheet ended the third quarter with total assets of $17.9 billion, of which $2.9 billion was cash, cash equivalents, and short-term investments.
Total liabilities in the third quarter were $13.5 billion, of which $10.2 billion was deferred revenue, indicating that Palo Alto Networks received prepayments from some customers. As services are provided, that money is written off as a liability and recognized as revenue.
Palo Alto Networks has a compelling strategy, the financial strength to execute it, and the products and partnerships to enable its success. Additionally, Wall Street analysts have a consensus rating of Overweight for Palo Alto Networks stock with a median price target of $340, indicating that Wall Street believes the stock will rise.
Given Palo Alto Networks' many strengths, the company's stock is a worthwhile long-term investment, especially now that its share price is down.
