Palo Alto Networks Just Made a $25 Billion Bet on 1 Security Platform. Is the Stock a Buy?
Key Points
Security buyers are consolidating their spending with fewer vendors, and Palo Alto keeps adding to the menu.
Free cash flow margins have hovered near 40% over the past three years.
With its product portfolio set, the focus shifts to integration.
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Every sector has a dominant platform that rewards the investors who keep adding to their position. Cybersecurity has one too.
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Security budgets rarely get cut. They increase every time someone gets hacked, and the recent breach of Mexico's government is the latest reminder.
Palo Alto Networks (NASDAQ: PANW) sells the high-end cybersecurity platforms those organizations are buying. For years, the company has been building a broader lineup so clients can buy more of what they need from one vendor instead of stitching together a dozen tools. The CyberArk acquisition, which closed Feb. 11, fills a critical gap in identity security: the systems that decide who gets access to what.
Image source: Getty Images.
Fewer vendors, greater pricing power
The three biggest stocks in the space each approach the market differently. Microsoft (NASDAQ: MSFT) bundles protection with the Office subscription. CrowdStrike (NASDAQ: CRWD) wins on product quality in endpoint security. Palo Alto is building its moat as the one-stop shop.
If security spending continues to consolidate, that approach becomes its real advantage. New platform wins will show whether those dollars are flowing its way.
Roughly 80% of revenue comes from subscriptions and support, which are recurring in nature. Every solution a client adopts deepens the relationship, and CyberArk just added another key offering. Existing clients on Palo Alto's platform have a net retention rate of 119%, meaning they spend more each year even after accounting for attrition.
The product line that secures remote and cloud access brings in more than $1.5 billion in subscriptions, and the software that uses artificial intelligence (AI) to automate threat detection has crossed $500 million in revenue.
Integrating a $25 billion acquisition is no small task. If Palo Alto stumbles, it risks losing market share to key competitors like CrowdStrike and Fortinet.
Strong margins, but can they hold up?
Free cash flow margins have averaged 38% over the past three years. That's partly a feature of the business model. Palo Alto collects cash up front on multiyear contracts, so cash flow runs ahead of the revenue it has actually earned. That's good, but not the point. What matters more is whether the company retains those clients.
Management is targeting 40% margins by fiscal 2028, up from 37% this fiscal year. The CyberArk deal was funded mostly with stock, so per-share cash flow will take a few quarters to catch up.
Palo Alto has rarely been a cheap stock. At 32.5 times this year's projected free cash flow, it still isn't. But most investors have at least one stock they wish they'd owned more of, rather than waiting for a better price. This one is worth adding to.
Should you buy stock in Palo Alto Networks right now?
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Bryan White has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends CrowdStrike, Fortinet, and Microsoft. The Motley Fool recommends Palo Alto Networks. The Motley Fool has a disclosure policy.
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