Clouds Clearing and Growth Looks Robust for Palo Alto Networks

Managing Director, Daniel Ives updated his coverage of Palo Alto Networks (PANW) from Neutral to Outperform. 

PANW has established itself as one of the premier network security vendors in the market over the last decade as the company’s next generation firewall solution has changed the landscape of the cyber security market for years to come as the company has handily exceeded 15%-20% industry growth rates year in and year out. We have seen the company’s impressive evolution take hold as share gains vs. the likes of traditional networking player such as Cisco were major fuel in its growth engine, a differentiated and expansive end to end NGFW product suite, a successful product expansion with its Traps offering and slew of other modules going after massive network security opportunity, and most recently introducing its Application Framework architecture. In a nutshell, we see Palo Alto Networks making good and steady progress in developing an integrated cloud security portfolio, with the recent acquisition of RedLock adding cloud compliance technology to an already extensive set of cloud security offerings with GlobalProtect cloud services as the golden jewel of the product portfolio in our opinion.

We are upgrading Palo Alto Networks to OUTPERFORM from NEUTRAL and raising our price target to $265 from $225. Over the last month our conversations with customers and partners as well as our field checks have given us incremental confidence in the Palo Alto growth story over the next 12 to 18 months. We note that heading into 2H of 2018 we saw a number of dynamics that worried us on PANW including: 1) sales force disruption, 2) a new CEO that was ready to do significant M&A, 3) lack of preparation for the impending cloud shift, and 4) a firewall refresh cycle that was unpredictable in terms of sustainability into 2019. To this point, we have spent a lot of time in the field analyzing and dissecting these lingering issues which we believe have kept a lid on the stock and now appear to be mostly worries in the rear view mirror based on recent positive feedback from customers and channel partners. That said, while there are still some wrinkles to iron out on the product strategy (Application Framework traction) looking ahead and competitive landscape with laser focused cloud competitors such as Zscaler carving out a next generation cloud market, we strongly believe for PANW that numbers for FY19/FY20 look conservative and the Street is still underestimating the magnitude of this existing firewall refresh for the company as a major tailwind over the next few years. With the company’s GlobalProtect cloud platform currently at roughly 7,000 customers and growing with a trained specialized sales force now better equipped to go after this key market opportunity, we believe cross-selling opportunities could expand meaningfully from here which could potentially add another 150 bps to 200 bps of billings growth over the next 12 to 18 months. We also note that the firewall refresh (~every 5 years) and high attach rates remains a key variable at the center of the debate on this name in terms of the timing of these upgrades and potential product growth tailwinds heading FY19/FY20 that we believe could lift Street estimates as execution/pipeline looks robust in the field thus far in the January quarter and into the rest of FY19.

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