Is It Too Late to Buy Palo Alto Networks Stock?

Shares of cybersecurity powerhouse Palo Alto Networks (PANW 3.26%) experienced a resurgence in recent weeks, rising past $300. That is, until May 20, when the company reported earnings for its fiscal third quarter, which ended April 30.

Suddenly Palo Alto Networks stock plunged. Does this create a buying opportunity? Perhaps the drop signals a reason to avoid the stock? 

Answering these questions requires taking a deeper look into Palo Alto Networks to understand where its business is at today. This entails evaluating its stock as an investment for the long haul.

Palo Alto Networks’ new growth initiative

The decline in Palo Alto Networks’ stock price after its recent earnings announcement can be attributed to the company’s fiscal Q4 revenue guidance of $2.2 billion, which fell short of Wall Street’s expectations.

The company’s conservative Q4 sales guidance, which is only slightly ahead of the prior year’s $2 billion, was driven by its decision to shift to a new business strategy. One piece of that involves offering its Cortex cybersecurity platform for free for a period of time.

It’s doing this to incentivize customers to move away from rivals, and consolidate their cybersecurity needs with Palo Alto Networks.

As a result, the firm expects modest Q4 revenue growth as customers take advantage of the offer. This in turn drove the company’s conservative Q4 guidance. But its tepid year-over-year sales growth is only a short-term situation.

Customers who opt for the free offer are signing contracts for three- to five-year terms, well beyond the free period, which lasts only as long as it takes a client to transition away from an existing cybersecurity vendor. Over the long run, Palo Alto Networks should see solid revenue growth.

Why Palo Alto Networks adopted this strategy

Palo Alto Networks adopted this new strategy, which it calls platformization, because management noticed a trend among customers. Clients used to buy a hodgepodge of cybersecurity products from multiple merchants, but now were consolidating their spending on a smaller group of vendors.

To incentivize businesses to choose its platform amid this industry consolidation, Palo Alto Networks took the aggressive tactic of offering Cortex for free. Platformization also provides another benefit to the company.

Palo Alto Networks can generate greater annualized recurring revenue (ARR) from customers that adopt its full platform, rather than buying individual products such as a firewall. ARR measures the total revenue the company collects from its customer contracts over an annual period.

Customers who buy a stand-alone cybersecurity product from Palo Alto Networks spend an average of $200,000 in ARR. But a customer that adopts one of the company’s three platforms has an average ARR of $2 million.

Its platformization strategy was introduced in the company’s fiscal second quarter, and results since then are promising. Palo Alto Networks captured 65 platformization sales in Q3, a 40% increase over Q2.

Also, despite lost revenue from the free promotional offer, the company’s Q3 sales rose 15% over the prior year to $2 billion.

To buy or not to buy Palo Alto Networks stock

Palo Alto Networks is so confident in its platformization strategy, it set a goal of growing ARR to $15 billion by 2030. That’s massive ARR growth, considering in its current fiscal year the company expects ARR to hit $4.1 billion.

Palo Alto Networks is positioned to pull it off. Not only does the firm’s free promotion provide customers with an incentive to switch, Palo Alto Networks continues to evolve its solutions to keep pace with the ever-changing cybersecurity landscape.

On May 7, the company rolled out new AI-enabled capabilities designed to stop cyberthreats using artificial intelligence in a bid to battle AI with AI. On May 15, Palo Alto Networks and IBM announced a partnership where the latter’s army of over 1,000 consultants will help sell the former’s cybersecurity solutions.

Palo Alto Networks also possesses strong financials. Its fiscal Q3 net income of $278.8 million was more than double the prior year’s $107.8 million. Its balance sheet at the end of Q3 included $17.9 billion in total assets, with $2.9 billion of that in cash, cash equivalents, and short-term investments.

While Q3 total liabilities were $13.5 billion, $10.2 billion of that was deferred revenue. This shows Palo Alto Networks received up-front payments from some customers — and once services are rendered, that money can be removed as a liability and recognized as revenue.

Palo Alto Networks has a compelling strategy, the financial strength to pull it off, and the products and partnerships to enable success. Also, the consensus among Wall Street analysts is an overweight rating with a median share price of $340 for Palo Alto Networks stock. This indicates Wall Street’s belief in upside for shares.

Given Palo Alto Networks’ many strong qualities, its stock is a worthwhile long-term investment, especially now that its share price has dipped.