Zscaler Closes Out Q2 Above Our Estimates As Macro Outlook Remains Tight

We are maintaining our $170 fair value estimate for narrow-moat Zscaler ZS after the firm closed out a mixed second quarter with strong growth tempered by continued macroeconomic tightness. While the turbulent macroenvironment continues to affect near-term results, we remain optimistic of Zscaler’s long-term opportunity. We believe that Zscaler’s zero-trust security offerings continue to be industry leading, and that the firm stands to materially benefit from the convergence of networking and security. Not only does the firm benefit from these secular tailwinds, but the firm has also built an economic moat around its business through strong customer switching costs and network effects associated with its solutions. With Zscaler’s shares down more than 10% after hours, we think that the firm is trading at an attractive price for long-term investors.

Zscaler’s second-quarter top line grew 52% year over year to $388 million. While top-line growth remains strong, management highlighted elongated sales cycles as customers continue to scrutinize IT spending amid a tough macroeconomic environment. Across our cybersecurity coverage, we have seen firms highlight customers opting for shorter contract durations and taking more time in making purchasing decisions, especially as it comes to bigger deals. We are forecasting macro tightness throughout calendar 2023 with a demand rebound for Zscaler’s solutions in calendar 2024 as the macroenvironment normalizes.

Like other cybersecurity vendors, Zscaler also saw deceleration in customer acquisition. Year-over-year growth in customers with annual recurring revenue, or ARR, of more than $100,000 and $1 million clocked in at 33% and 51%, respectively. These growth rates are considerably lower than what Zscaler has produced over the last few quarters. The firm’s RPO, or remaining performance obligations, also showed signs of cooling down, with total RPO expanding 44% year over year but 5% sequentially.