Palo Alto Networks (NASDAQ:PANW) is currently going through a major transformational stage as the firm prioritizes platformization of their security products as IT departments seek to simplify their IT infrastructure through a single-vendor approach. With the addition of their copilot and GenAI-related security features, I believe Palo Alto has the ability to realize continued top-line growth and margin expansion as the firm broadens their ability to upsell additional security products. I anticipate that Palo Alto will realize continued growth as the firm leans in on their partnerships with IBM and Accenture as a preferred security vendor for the next generation of GenAI threat vectors. I reiterate my BUY recommendation for PANW shares at a price target of $352.74/share at 13.34x eFY25 price/sales.
As a disclaimer, my forecast and price target has been reduced from my previous recommendation pre-Q2’24 earnings. The report can be found here:
Palo Alto Networks Still Has Gas In The Tank
Palo Alto Networks Platformization Strategy
Palo Alto Networks set the stage in their Q3’24 earnings call for future periods as the firm transforms their strategy more towards platformization and away from single-product sales. Though the strategy may appear less appealing up front from a comps perspective, I believe that this form will allow for the firm to further bolster sales in the long run through cross-selling additional subscription features, such as their AI Access Security, AI SPM, and AI Runtime Security features. From an IT integration perspective, I anticipate enterprise customers to further gravitate towards the single-security platform formfactor as this allows for simplicity and less customization and crosstalk between security features. I believe this will allow for enterprises to better manage their opex as less complexity allows for less overhead. I also expect that the single-platform solution will become the preferred method for cybersecurity departments, as it may lower the total capital expenditure and minimize vendor exposure as a result. Management mentioned in their Q3’24 earnings call that customers that bring in Palo Alto’s platform suite realize a 30-40% improvement to efficiency and better security outcomes as a result. Management also discerned that customers that utilize a single-platform solution realize a 10% reduction in security-related platform costs. The drive towards bringing customers onto a unified platform has driven meetings up by 30%. Though it remains too early to determine the success of this transition, I believe that this strategy will catch on as IT departments become more complex with multi-cloud platform utilization in tandem with private data centers.
Given this transition to platformization, management has taken the initiative to assess the entirety of their customer base to target transformational sales towards their single- and multi-platform solutions. Management discerned on their Q3’24 earnings call that of their top 5,000 customers, half have landed two or more platforms with 20% on Prisma Cloud and 40% on Cortex. Fully platformized customers’ ARR falls substantially higher than landed customers at $2-$14mm vs. $200-$800k. With the goal of bringing more landed customers into their full-spectrum platform model, management expects to achieve $15b in nextgen ARR by FY2030 with a runway of 2,500+ platformization sales. In total, Palo Alto has 900 customers that have made the transition with 65 additions in Q3’24 alone.
In addition to their platformization strategy, Palo Alto is actively releasing new AI features across their platforms, including a basic and advanced copilot feature powered by Precision AI, that can help eliminate the complexity of security operations and can effectively improve productivity across cybersecurity departments. Their copilot feature is available on Strata, Prisma Cloud, and Cortex, and provides actional insights, automation, and guided actions for a quick response to security threats and for daily security operations. I believe these copilot features will further push for platformization given that the offering uses natural language processing to simplify security operations and may allow for faster incident detection. These features may also be substantially appealing to firms seeking to minimize opex within their IT and security departments as they reduce the complexity of security operations and allow for more breathing room in staffing departments.
Palo Alto Networks Partnerships
In addition to this tactic, Palo Alto has also entered into a partnership with IBM (IBM) to deliver industry-specific capabilities on XSIAM using IBM watsonx. This partnership will enable over 1,000 IBM security consultants to leverage the Palo Alto portfolio and has the potential to further drive platformization sales. The partnership involves a few moving parts, including the acquisition of IBM’s QRadar SaaS assets, QRadar IP, and IBM’s on-prem QRadar customer list. The total consideration for the deal comes out to $500mm plus earn-outs. In turn, Palo Alto will become IBM’s preferred cybersecurity partner across network, cloud, and SOC, and will potentially drive business to Palo Alto’s security platform. IBM will also platformize on Palo Alto’s products and integrate watsonx into Cortex XSIAM to deliver Precision AI solutions, further bolstering Palo Alto’s AI-related offerings. Once the deal is closed, Palo Alto will migrate QRadar customers to their XSIAM offering over the next few years and will begin recognizing revenue in eFY25. Accordingly, management anticipates some drop-off from QRadar’s customer base, which brought in $100mm in SaaS revenue during CY23.
Palo Alto has also expanded their strategic alliance with Accenture to combine Palo Alto’s Precision AI technology with Accenture’s secure GenAI services to help bolster AI security features. I believe this partnership will create further synergies between the two firms as enterprises seek to more heavily utilize GenAI to automate and optimize business operations in a secure fashion. The strategic partnership will be driven by Accenture’s comprehensive AI diagnostic services that will utilize Palo Alto’s Prisma Cloud AI Security Posture Management and AI Access Security to ensure the security posture on customers’ LLM/AI applications. Given the rate of transformation across GenAI applications, I believe that this offering will realize significant growth as GenAI opens the door for new threat vectors that may leave a sea of company data exposed. Given that enterprises run on a variety of on-prem, cloud, and hybrid solutions, I anticipate that enterprises will seek to secure their data before jumping into novel GenAI solutions.
Palo Alto Networks Financials & Forecast
Palo Alto Networks reported 15% topline growth in Q3’24 with 80% of sales deriving from subscription and support services. This resulted in strengthening year-to-year margins, with adjusted operating income improving from 23.6% in Q3’23 to 25.6% in Q3’24. Management forecasts the eFY24 operating margin to fall within the range of 26.8-27%, an improvement from the previous year’s 24% operating margin.
Corporate Reports
Looking to eFY25, I am adjusting down my forecast as it pertains to a slightly slower growth rate than initially anticipated. Though I anticipate Palo Alto to experience some tailwinds as a result of upselling their AI features across their security platforms, I do anticipate some minor adjustments to the sales cycle as they adjust to the platform model.
Palo Alto Networks: Valuation & Shareholder Value
Corporate Reports
PANW shares currently trade at 13.64x TTM price/sales. Comparing my current forecast to my previously reported estimates, I will be significantly lowering my price target from $427/share to $352.74/share at 13.34x eFY25 price/sales. The adjustment down is primarily due to the more challenging sales environment and the adjusted comps due to platformization. As a result, I anticipate PANW shares to remain relatively range-bound to its price/sales multiple until the macro environment improves. Given the price pullback that resulted from Q2’24 earnings, I believe investors can realize modest share appreciation when considering the current price level. I reiterate my BUY recommendation with a price target of $352.74/share.
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