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Palo Alto Networks (PANW)

6/30/2014

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Palo Alto Networks is a cybersecurity company protecting enterprise, government and service provider customers. Their security platform  brings together all key network security functions, including advanced threat protection, firewall, IDS/IPS, and URL filtering. As such,  organizations can safely enable the use of all applications, maintain complete visibility and control and at the same time protect themselves from internal or external attacks.

The company has currently more than 17,000 customers in over 120 countries across multiple industries, including 70 of the Fortune 100 companies. IT research firm  Gartner ranked them a enterprise firewall market leader in 2011, 2012 and 2013 (published April 2014).

We sell our platform through a high touch, channel fulfilled sales model. Our business is geographically diversified, with 63% of our total revenue from the Americas, 23% from Europe, the Middle East, and Africa (EMEA), and 14% from Asia Pacific and Japan (APAC) in fiscal 2013. As of July 31, 2013, we had over 13,500 end-customers in more than 120 countries.

The company was fighting a long battle with rival Juniper Networks over infringement of it's patents, but that was settled in May for $175 million, in addition, both companies agreed not to sue each other for the next 8 years. The founder of PANW Nir Zuk, used to work at Juniper and of the pioneers in cybersecurity and firewall development,  a knowledge which he later used to create Palo Alto Networks.

They currently have only 4% of the firewall market, but have grown 50% in the recent quarter, outpacing all competition. It is estimated, that security leaks and attacks cost companies and governments over 400 billion USD annually. As a result, major security companies are jumping over one another to develop the best solutions for their clients. But Palo Alto Networks has already done it, and is far ahead of the crowd. As of 2013, they held 19 patents, with 55 additional applications expiring in years 2017-2029

Here is a snapshot of PANW 3 year financials:
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Palo Alto has grown steadily over the years, with gross margins around 72%. The company has not achieved a profit during the last year, due to an increase in R&D and sales expenses of 62% and 73%.

VALUATION

The company is not expected to turn a profit next year, so I can only value it based on sales. They are currently trading at a P/S ratio of 11.7. However the company is growing by 50%, which would translate to a P/S of only 5.8. Their closest competitor Checkpoint Software (CHKP) trades at a ratio P/S of 9, but is growing a measly 5%, which is only a fraction of PANW growth.

I believe Palo Alto Networks has significant upside, based on their competitive advantage and future industry growth. Software companies like this usually achieve exploding profitability once they main R&D is over, after which they just collect service payments at no extra cost. 
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