Palo Alto Networks continues to play the long game, much to Wall Street's chagrin

By Therese Poletti

Palo Alto Networks still is dealing with investor chagrin about the big shift in strategy it announced last quarter, in an effort to eventually boost revenue growth.

On Monday, the cybersecurity company reported fiscal third-quarter earnings that were better than expected, but its fourth-quarter forecast failed to exceed current expectations. Palo Alto's shares (PANW) tumbled about 9% in after-hours trading, as investors continued to assess the implications of its big strategy shift.

Last quarter, Palo Alto lowered its full-year forecast and said it was shifting to a platform model, to get its customers to use more of its products, while it bears some of the cost. The day after earnings, the stock had its worst day ever, falling over 28%, as analysts lowered their estimates and price targets. Shareholder lawsuits have since ensued.

"Despite the many demand drivers we're seeing, we're beginning to notice customers are facing spending fatigue in cybersecurity," Palo Alto Networks CEO Nikesh Arora told analysts in February. "This is new, as adding incremental point products is not necessarily driving a better security outcome for them."

On Monday's call, some analysts showed that they were still concerned, or at least had more questions about the company's unexpected pivot. Brian Essex, an analyst with JPMorgan, asked about the "duration that you anticipate pursuing these efforts?" Arora said it was the company's new strategy, "so I think in that sense it will continue for awhile."

Later, in answering another question, executives pointed out that "every time these deals will come up for renewals, we will have the opportunity to present more services and capability onto the platform."

The company also touted a recent deal announced with IBM Corp. (IBM), in which Palo Alto Networks will become IBM's preferred cybersecurity partner. As part of the deal, Palo Alto acquired IBM's QRadar SaaS assets, including QRadar's intellectual-property rights, for $500 million in "upfront cash consideration at close."

One analyst asked why Palo Alto felt it necessary to buy those assets from IBM, which he estimated was bringing in about $100 million in revenue. Arora said the deal will be another opportunity for the new strategy to transition customers to a new contract. IBM, he said, gets an "earn-out based on how many of those customers transition to us."

Last quarter, Macquarie Research analysts said they viewed the pivot as the company "putting its money where its growth is," and that its muted revenue guidance for fiscal 2024 and 2025 was a "necessary, transitory consequence" as it maintained a neutral view on the stock.

Monday's results and guidance reconfirmed that it will take time for Palo Alto's new strategy to pay off. But clearly, some investors are still jittery about what they as a risky change.

-Therese Poletti

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05-20-24 2117ET

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