Perspectives - PANW - Gross Mispricing
PANW is Best Conditioned to Thrive Amid Cybersecurity Fragmentation
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Sources of Alpha: Complexity of the Business
Expected Price Appreciation: 100% from $330 within 3 years
The following map illustrates the complexity and extreme fragmentation of the cybersecurity industry (click the link for a better look). And because of continuing cloud adoption, multi-cloud trends, IoT, 5G, remote working, edge computing, IT skills shortages, and other dynamics, it’s also one of the fastest-moving industries in tech. Therefore, unlike some industries that have become overly consolidated and as a result experience a lack of innovation, the cybersecurity industry will continue to be dominated by BoB startups gaining solid reputations in niche areas.
In sharp contrast to the extreme fragmentation, one of Chief Information & Security Officers’ (CISOs) top priorities is vendor consolidation. 78% of CISOs have 16 or more tools among their cybersecurity defenses.
However, CISOs want to have their cake and eat it, because they also want the BoB solution for each cyber threat. Reflecting on this, PANW have to be the optimal investment choice to capitalize on this industry-wide dynamic. Since Nikesh Arora took the helm as CEO in Jul-18, PANW have executed a slick and prolific M&A strategy whereby they acquire various BoB startups (Redlock for CSPM, Twistlock for container security, Cloudgenix for SaaS-based SD-WAN, etc.) and seamlessly integrate them into the broader security platform. And Arora has stated that PANW will continue to opportunistically acquire BoB startups in order to adapt to the ever-changing landscape. Usually such frequent M&A results in shareholder value destruction, however, it appears that with Arora’s leadership, PANW have the secret sauce for efficiently integrating bolt-on acquisitions.
PANW’s strategy doesn’t stop in identifying and integrating the BoB talent, however. The industry’s broadest security platform, harmoniously stitched together with BoB solutions and the deepest understanding of core security principles, is converted into impressive revenue growth thanks to PANW’s unique S&M prowess.
We’ve published a full report on PANW, exclusively available to Convequity Newsletter subscribers. So, here we’ll just give you a glimpse into how undervalued PANW currently is by using Check Point Software (CHKP), Zscaler (ZS), and Crowdstrike (CRWD).
PANW’s business can be broadly divided up into Network Security and Cloud & AI Security. Arora refers to these divisions as NetSec and ClaiSec. Now we’re going to simply use the market caps of CHKP, ZS, and CRWD to shed some light on PANW’s gross undervaluation.
NetSec consists of on-prem security (physical appliance or virtual NGFWs + subscriptions) and SASE (network security delivered as-a-service). The high majority of CHKP’s revenue comes from on-prem security and the high majority of ZS’s revenue comes from SASE.
Therefore: PANW’s NetSec value estimation = CHKP mkt cap of $16.3bn + ZS’s mkt cap of $28.5bn = $44.8bn
ClaiSec consists of cloud security (CSPM, CWPP, container security, microsegmentation, etc.) and security infused with AI (SOAR, EPP, etc.). The high majority of CRWD’s revenue comes from these two areas.
Therefore: PANW’s ClaiSec value estimation = CRWD’s mkt cap of $52bn = $52bn
PANW’s total value estimation = $44.8bn + $52bn = $96.8bn
PANW’s current mkt cap = $36bn
Potential return = 2.7x
The potential return is probably higher when taking into account PANW’s crossover synergies. This is why we project that PANW have fantastic opportunity to become the 1st $100bn pure-play cybersecurity company – investors just need to notice the value up for grabs. FYI, our DCF valuation came in around $70bn to $80bn.
We don’t believe there should be a lower valuation for any quality discrepancies. As has been proven time and time again in Gartner Magic Quadrants and various independent security tests, PANW are the best performing provider for network security. And as previously noted, they’ve acquired the best niche security solutions for their Cloud & AI Security division. Therefore, we strongly surmise PANW’s tech is better quality than CHKP’s and ZS’s and probably on par with CRWD’s.
Lastly, we note profitability comparisons of the 4 companies mentioned in this exercise. CHKP is highly GAAP profitable but, as a consequence, is suffering low single-digit growth. ZS, CRWD, and PANW, however, are all very similar in terms of gross margin (> 75%), negative operating margin (< 10%), and positive FCF margin (> 30%). So, from the profitability angle, we also believe this valuation exercise and its conclusion is pretty fair.