Does anyone remember the gunshots heard all over the world? This was recognized as the Battle of Lexington and the beginning of the American Revolutionary War. A major strategic shift toward Palo Alto Networks' platform could be a “blow heard throughout the firewall world.”
Palo Alto Networks stock is popular with cybersecurity investors. The company's stock price has increased about 400% since January 2020. This week has been a tough one, though. Shares fell 25% on Wednesday after the company issued weaker-than-expected guidance related to a significant change in its approach to selling its cybersecurity portfolio.
Why did the stock price crash occur? The company's profits were good. Revenues increased 19% year-over-year, and second-quarter non-GAAP earnings were $1.46 per share, an increase of 39% year-over-year. But Palo Alto CEO Nikesh Arora told investors on Tuesday's earnings call that Palo Alto is accelerating its cybersecurity “platformization” with promotions and incentives that bundle its many cybersecurity products. He said he intends to lead major changes in the industry.
Stock prices fell as investors heard, “There's a price war!” Let me explain what this means.
It's firewall fireworks time
Arora is considered one of the most visionary leaders in the field of networking and cybersecurity. Under his leadership, the company has carefully crafted its portfolio of cybersecurity and network security products through years of in-house development, integration, and surgical M&A. In addition to being a leader in next-generation firewall sales, Palo Alto is also a leader in the fast-growing Secure Access Service Edge (SASE) segment and has a strong foothold in Zero Trust and Cloud Security. .
One effect of platforming (meaning actively soliciting new customers to use the entire portfolio, not just the points product) is that Palo Alto has lowered its revenue outlook and subsidized new customer acquisition. He suggested that he pay money. That dealt a huge blow to stock prices.
This is a classic game. Long-term gains come with short-term pain. Sacrificing short-term profits for long-term market share gains. It might work. Let's see why.
Let's start with the firewall. Firewalls provide a basic network security gateway and are one of the most widely used cybersecurity products. Palo Alto coined the term Next Generation Firewall (NGFW). This means a firewall that does deeper network packet inspection to put together a complete picture of the threat. Firewalls are a huge market, and this move propelled Palo Alto to the top, taking market share from other large companies. The firewall market is crowded with competitors such as Check Point Software, Fortinet, Cisco, and Juniper Networks.
But Palo Alto didn't stop there. The company acquired his CloudGenix in 2020 and added Software-Defined Networking (SD-WAN), which became the genesis of the SASE market. It also includes acronyms for Zero Trust Network Access (ZTNA), Cloud Native Application Protection (CNAP), Cloud Security Posture Management (CSPM), and many other cybersecurity products. Networking giant Cisco has been devastated by Palo Alto's move to integrate the cybersecurity market into a more comprehensive portfolio. Palo Alto is constantly growing its revenue at double-digit percentages, while Cisco's efforts in this area remain at single-digit percentages.
Thorough pricing of cyber customer experience
The cybersecurity market is changing rapidly, and Palo Alto seems to recognize that. Firewalls are built for traditional infrastructure, but they're less useful in the cloud, and the market is starting to realize that. Firewall competitor Fortinet had to lower its earnings forecast twice last year due to weak sales.
Cisco has also struggled to gain traction in the cybersecurity space, and its network security products aren't selling as well as they used to. Here's why: It's about pricing and product availability, which is what his Arora discussed on the conference call about revenue. Cisco is known for relentlessly selling multiple product lines across its portfolio.
Arora said the company will be aggressively investing in customer conversion as the industry faces increasing “price fatigue.” They don't want dozens of cybersecurity acronyms and point products. They want a portfolio, a platform.
“We are promoting platformization, and I think we should accelerate this even more,” Arora said at the results conference.
When Arora talked about platforming, investors were scared to hear about bundling and discounts. But he's thinking long-term. He thinks about his customers and how Palo Alto can gain greater market share. It's time for the Great Firewall War.
A firewall war would cause great damage. Palo Alto's full-year bill is expected to be between $10.1 billion and $10.2 billion, compared to previously between $10.7 billion and $10.8 billion.
Is platform acceleration on the horizon?
It's a bold bet and a big move. This is reminiscent of Adobe Systems' groundbreaking move from licenses to annual subscriptions in 2012. At the time, the stock price was depressed and the strategy was questioned, but it paid off in the long run. Since this change, Adobe's stock price has increased more than 500%.
At a basic level, Arora described Palo Alto's strategic shift as an “investment” in converting new customers to Palo Alto's cybersecurity platform. This comes in the form of a wide range of incentives and bundles of Palo Alto products, from firewalls to cloud security to SASE.
The rationale for building a platform is that cybersecurity point products need to be better integrated, and customers need to be able to reduce administrative overhead by using products bundled with the platform.
“Now is the right time to accelerate consumption of Palo Alto's many security products,” Arora said. “Customers are facing cybersecurity spending fatigue…platform adoption is their only viable option.
Cybersecurity professionals are bombarded with hundreds of cybersecurity products added as acronyms. Purchasing and managing these products separately increases pricing and management overhead. Palo Alto has identified customer pain points that can be leveraged compared to competitors by adding more value to their platform or portfolio.
Arora said Paro is “validating” platformization in the cybersecurity industry and believes that if the company can successfully make a strategic shift, customers will turn to platformization in droves. He announced an audacious goal of reaching $15 billion in annual recurring revenue (ARR) by 2030. On the earnings call, he said 79% of Global 2000 companies trade on two or more elements of Palo Alto's platform.
“Our guidance does not change the global demand outlook. Our guidance is the result of a shift in our strategy,” Arora said.
In the long run, this strategy is probably the right one for the industry. Palo Alto has done a great job of absorbing his one of the most extensive portfolios in the industry. They can also more deeply integrate their products that collect data from a variety of devices and use that data and AI to drive more comprehensive cyber solutions. And there's a huge opportunity to make cybersecurity-weary customers happier.
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