Morningstar | Palo Alto Posts Another Record Quarter; Acquisitions Boost Cloud Strategy; Maintaining $305 FVE. See Updated Analyst Note from 29 May 2019
Narrow-moat Palo Alto Networks' 28% year-over-year revenue growth in the third quarter was higher than our expectation and resulted in another record quarter. Firewall sales continued to showcase positive momentum with product sales growing by 28%. Subscription and support also grew by 28% and we expect Palo Alto's software platform approach of addressing various security touch points holistically to continue strong growth in this arena. We like that Palo Alto is seeking to address the complexities associated with integrating and managing disparate point solutions. The two announced acquisitions of TwistLock, for container security, and PureSec, for serverless security, will be weaved into Palo Alto's Prisma cloud security platform and provide enterprises with coverage from development to cloud deployment and monitoring. With Palo Alto down about 5% afterhours, we believe the transition from longer-term firewall subscriptions toward shorter contracts that mimic SaaS consumption models may be influencing the sell off. We continue to positively view Palo Alto's strategy in growing outside the data center through automation and a robust cloud-based security portfolio. Palo Alto remains the best idea in our cybersecurity coverage and we are maintaining our fair value estimate of $305 per share.We believe that Palo Alto's evolution toward various aspects of cloud security and automation are greatly supported by being the firewall leader and not resting on its existing credence. Strong product growth indicates that Palo Alto is not overlooking the importance of its firewall revenue stream and management indicated that average price per firewall is increasing due to additional features being integrated. We see Palo Alto's Prisma and Cortex platforms as ways to grow sales at existing firewall customers and as entry points for enterprises attempting to consolidate the chaotic nature of controlling network, cloud, and endpoint security with limited resources.
Guidance for the fourth quarter includes revenue in the range of $795-$805 million (21.5% growth at midpoint) and non-GAAP EPS of $1.41-$1.42 per share. We expect Palo Alto to exceed the revenue guidance slightly due to continued broad-based strength, with heightened demand in areas like cloud-delivered security and automated solutions through Demisto products (Palo Alto closed the Demisto acquisition in March). The company is investing for growth and is ramping up its sales team as it expands the reach of its solutions, but we still expect Palo Alto to create operating leverage in the coming quarters through robust revenue growth, software sales expanding margins, and a strong customer base to leverage into purchasing additional features through bolt-on subscriptions.
The announced acquisitions of TwistLock and PureSec fit into Palo Alto's strategy of providing various aspects of cloud-based security in a comprehensive platform. TwistLock is a provider of cybersecurity for virtual machines, containers, and serverless applications and processes, and Palo Alto will pay $410 million in cash for the company. Palo Alto also announced the acquisition of PureSec (terms not disclosed), who developed a serverless security platform, which provides application security for AWS Lambda, Azure Functions, Google Cloud Functions, and IBM Cloud Functions. As more developers and operations teams create and utilize applications based on containers and through serverless environments, we believe Palo Alto purchasing these companies gives its platform a wider extension outside of the core networking security environment. In addition, we view this movement toward developer security as a wise way to integrate its products across more areas within enterprise teams, in turn making Palo Alto products sticky within the realms of developers, operations, and security.
Palo Alto Networks provides a platform that allows enterprises, service providers, and government entities to secure their organizations. The company's platform uses a traffic classification engine that identifies network traffic by application, user, and content and provides security across the network, endpoint, and cloud. The company's product, subscription, and support offerings include: firewall appliances and software; and Panorama, which is a centralized security management solution for global control of various firewall appliances and software deployed on an end-customer's network as well as in their instances in public or private cloud environments as a virtual appliance or a physical appliance.
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