Shares of Palo Alto Networks(NASDAQ: PANW) were hammered after the cybersecurity company lowered its guidance and announced a shift in strategy earlier this year. However, at least one prominent figure invested in the company in the aftermath. That investor was former House Speaker and current U.S. Rep. Nancy Pelosi.
While known for her role in politics, Pelosi has a strong investment track record, especially in the tech sector. In fact, her portfolio was up a whopping 65% in 2023. So when she invested in Palo Alto through options expiring in 2025, it certainly grabbed widespread attention. The use of options adds risk to the investment, but can supercharge her returns if she is correct.
The question becomes: Should investors follow Pelosi and invest in Palo Alto?
A stock sell-off
Palo Alto Networks surprised investors in February when the company lowered its outlook for its current fiscal year, saying it was beginning to see "spending fatigue" among its cybersecurity customers. It noted that customers are spending more on cybersecurity than IT, but they want to see a better return on their investment.
As a result, the company reduced its revenue guidance for fiscal year 2024 ending in July from a range of $8.15 billion to $8.20 billion to a new range of between $7.95 billion to $8 billion. The new outlook represents revenue growth of between 15% to 16% for the year.
It also lowered its full-year billings forecast, taking it to a range of between $10.1 billion to $10.2 billion, down from a prior outlook of between $10.7 billion to $10.8 billion. The new forecast would be between a 10% to 11% increase. Billings can be an indicator of future growth and point to a lower growth outlook for its fiscal 2025.
Growth stocks are generally valued off their anticipated future prospects. So when a company reduces its growth outlook, the market tends to react negatively. In the case of Palo Alto, investors sent its shares down 28% in a single day after its guidance revision.
A new strategy
In conjunction with its lowered guidance, Palo Alto also announced a strategy shift to help address the spending fatigue its customers were seeing by not getting incremental returns from adding new point solutions. Cybersecurity point solutions are generally used to address one specific problem, not provide a holistic solution. What this can lead to is organizations building a cybersecurity defense comprised of a bunch of disparate point solutions that don't work together. This can cost organizations more money while also leaving them more vulnerable to cyberattacks.
To address this, Palo Alto will transition all its individually sold point products onto one of its three main platforms. The company believes this "platformization" strategy will both help its customers and result in increased multi-platform wins.
However, this shift in strategy will initially come at a cost. Organizations don't want to be paying for duplicate cybersecurity solutions, so to entice customers to use its platforms, Palo Alto will let its customers use its additional services for free while they have contracts in place with other cybersecurity companies.
Management estimates this will equate to giving customers about six months of free product capabilities. It added that it expects this transition to pressure its top-line revenue and billings growth over the next 12 to 18 months.
While giving away some of its product capabilities for free will hurt growth short term, it does look like Palo Alto is making a prudent move. Without offering customers this financial incentive, it would be difficult to get them to rip and replace existing point solutions and move them on to one of its more unified platforms.
At the same time, Palo Alto will be able to better serve its customers with holistic solutions rather than as part of a bunch of mashed-together point solutions. This should save customers money, lead to better cybersecurity outcomes, and ultimately help Palo Alto reinvigorate growth in a few years.
Image source: Getty Images.
Not in the bargain bin
Despite its large sell-off, Palo Alto stock is not exactly in the bargain bin, trading at a forward P/E of over 50 and a price-to-sales ratio of over 11. Its price-to-sales ratio, in particular, is relatively elevated compared to where the stock has traded at in recent years.
PANW PE Ratio (Forward) data by YCharts
Ultimately, Palo Alto should be a nice winner over the long term, and I like its strategy shift. That said, the company will be going through a transition period over the next one to two years, and I don't see any reason to jump into the stock ahead of this at its current valuation. There likely will be better opportunities to buy down the road as it navigates this transition.
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Geoffrey Seiler has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Palo Alto Networks. The Motley Fool has a disclosure policy.
