Investors are holding their breath as they await results from the hottest stock currently, Nvidia. Releasing results even a day earlier could fray nerves, leading some investors to sell off their shares at the slightest hint of unfavorable news.
This scenario played out with Palo Alto, the largest pure-play cybersecurity stock by market capitalization. Despite delivering solid results—revenue for the second quarter of 2024 grew by 19%, surpassing both top and bottom line estimates—Palo Alto Networks revised its full-year revenue forecast downward. The new projection anticipated revenue growth of 15% to 16%, a decrease from the initially projected growth of 18% to 19%.
Following this announcement, its share price plunged by 21% in after-hours trading.
Palo Alto’s CEO, Nikesh Arora, provided a less-than-convincing explanation during a conference call with analysts. He attributed the revised guidance to a “shift” in strategy, mentioning a desire “to accelerate growth, platform migration and consolidation, and to assert AI leadership.”
Such a statement is as vague as it gets, seemingly leveraging the buzz around AI in hopes of casting a favorable light on the company’s stock. Unfortunately, it did not have the desired effect.
Arora also mentioned the company anticipated challenges with “a difficult customer,” leaving investors puzzled and seeking clarity. If the issue revolves around the loss of a challenging customer, it would be beneficial for the management to explicitly state so.
Speculating on the situation, it seems plausible that the customer in question may have pressed Palo Alto to upgrade its systems to address emerging threats in the AI landscape. This would require time for Palo Alto to develop new technology, during which it might struggle to sell its existing systems if customers begin demanding the newer solutions. It could indicate a trend where an increasing number of customers are seeking similar advancements, prompting Palo Alto to allocate resources towards these developments.
Palo Alto disclosed in its fiscal 2023 report that only three distributors accounted for 10% or more of their total revenue, yet no single end-customer represented more than 10% of total revenue. Therefore, the impact of losing just one customer should not be significant. Moreover, the guidance was adjusted downward by less than 3%, but the share price experienced a disproportionate decline of over 20%, suggesting an overreaction.
This sentiment was not isolated to Palo Alto. The broader cybersecurity sector felt the repercussions, as evidenced by the following declines:
Fortinet (FTNT) -5%
SentinelOne (S) -6%
Crowdstrike (CRWD) -8%
Zscaler (ZS) -8%
Despite the sharp drop in Palo Alto’s share price, it remains pricey. Based on my valuation, the fair value of Palo Alto’s shares is estimated to be between $203 and $218. Consequently, even after this decline, with shares priced at $288, Palo Alto is still considered overvalued.
