Palo Alto Networks stock is a way to play the cybersecurity boom

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Palo Alto Networks CEO Nikesh Arora said the company expanded its reach at a critical time for cybersecurity.

David Paul Morris/Bloomberg

While the Russian economy crumbles, state-linked hackers are likely to shift from ransomware-related crimes to attacks designed to maximize destruction and societal upheaval, the CEO of a major cybersecurity firm tells me. Yes, it’s kind of like an umbrella salesman saying it’s getting cloudy. But in this case, the clouds are really dark gray rumbles, and specifically for investors, umbrella sales are on the rise.

This was already happening, of course. The rise of cloud computing has swelled the number of devices connected to corporate and government networks — the “attack surface,” as cybercops call it. The pandemic has turned homes into millions of new construction sites. Not all workers were the image of digital hygiene – if mine was body hygiene, I’m afraid I would have been the guy who takes his own car on the train. I’m working on it, and meanwhile, cybersecurity spending will rise to $172 billion this year, from $155 billion last year and $137 billion the year before, according to technology researcher Gartner.


Palo Alto Networks

(ticker: PANW) is growing much faster than that: revenue grew 30% in its last quarter. Four years ago, the company was best known for its advanced firewall, a system that monitors and controls data traffic. He hired Nikesh Arora as CEO, who brought his business and deal-making acumen from his past work at Google and


SoftBank Group
,

but not much experience in cybersecurity. His assessment was that the industry had too many companies selling too many tools and that analysts in customer security operations centers, or SOCs, were spending too much time dealing with routine alerts.

So Arora embarked on a buying spree – 17 companies, a mix of small deals and medium-sized deals – that brought in new customers and expanded Palo Alto’s capabilities in two major areas. The first is to secure applications that run in the cloud. The second is to use data and artificial intelligence to automatically handle routine SOC alerts and help analysts focus on the toughest issues. As Palo Alto’s transactions slowed, he gained bigger clients. Market share rose from 2.5% to 4.5% on Arora’s watch, and stocks have returned an average of 31% annually, about twice the return of the S&P 500.

Arora says there is room for Palo Alto to gain 10-20% market share. The tech landscape changes every 24 months, he says, and “a new flavor of the year or decade is born,” as a startup develops a great product, but then stays in its lane.

“You have to give the customer the assurance that I’ll be there while we’re innovating,” he says. “As the technology evolves, I will solve the problem. You don’t have to go looking for the next start-up.

Regarding the Russian threat, Arora says that over the past few weeks he has seen companies that have spoken out against the war in Ukraine face significant DDoS or distributed denial of service attacks. These are designed to overwhelm networks with a flood of traffic. “My fear is that [it] grows as things get desperate for some people,” he says.

Even before the invasion of Ukraine, at an investor meeting last September, Palo Alto said nation-state cyber incidents had doubled in a year, to an average of more than 10 attacks per month. . Russian intelligence was linked to a 2016 hack of Democratic National Committee emails; a 2018 attack on key US infrastructure; and at the SolarWinds Violation in 2020. Russia has denied any involvement.

The latter was a so-called supply chain attack, which targets a network’s trusted third parties, in this case, a software tool created by SolarWinds. Palo Alto says he caught the offense early, but not everyone else. The hackers infiltrated major government agencies, including Homeland Security and Treasury. Asked about an example of future threats, Arora points to the shutdown of Colonial Pipeline ransomware last year and says to consider the “repercussions if a financial organization is unable to settle transactions for three days or more.”

I am ill-equipped to judge cybersecurity threats and products firsthand. Much of my hacking knowledge comes from a distant memory of the 1983 movie War gamesin which Matthew Broderick plays a teen computer whiz who searches for video games online and finds one called Global Thermonuclear War, hosted by Norad. Mayhem, as you can imagine, ensues.

Note: The screenwriters of War games consulted a Rand Corporation computer scientist who, in a 1967 article, unsuccessfully warned that the burgeoning field of networking made data vulnerable to attack. President Ronald Reagan reportedly saw the film, asked if such a breach was possible, learned that it was, and began work on the first national cybersecurity directive.

Where was I? Law. Analysts are mostly bullish on Palo Alto. I checked in with Brent Thill at Jefferies, who applauds Arora and likes that the deal seems done for now. He says there are plenty of companies in tech that are growing their revenue by 20-30% a year, but few are doing it with operating margins above 20%, and even fewer that also have good flows. cash.

Stocks look extravagantly priced at more than 60 times forward earnings projections, but in software accounting, revenue and earnings often lag free cash flow. Palo Alto shares trade at 30 times free cash flow.

Thill says other cyber companies he speaks to haven’t said anything about a post-pandemic downturn. Looking more broadly at the software package, he says price-to-earnings ratios have been topped for the past couple of years, but this year they’ve fallen to more ordinary levels as fundamentals continue to look strong. .

Favorites: app developer


IronSource

(SI) and video platform


Vimeo

(VMEO) for small caps;


Procore Technologies

(PCOR), a construction software publisher, among ETIs; and


Adobe

(ADBE) and


Microsoft

(MSFT) for large caps.

Write to Jack Hough at [email protected] Follow him on Twitter and subscribe to his Barron’s Streetwise Podcast.

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