Computer security topped tech headlines last week on the back of a Bloomberg report alleging that China has been implanting malicious chips in U.S. hardware. While hardware security is an issue all on its own, cyber security outfit Palo Alto Networks (NYSE:PANW) announced earlier in the week that it has everyone's back in the cloud computing space. Smaller competitor RedLock is getting scooped up for $173 million to help fortify Palo Alto's cyberspace tech.
The cloud and how RedLock can help
Over the last decade, the migration from on-site company computers and servers to the cloud has been accelerating. "The cloud" refers to an off-site data center that provides computing power, data storage, and other functions on demand, reducing the need for on-site heavy lifting and software installation. (Here's a quick primer from cloud computing pioneer Amazon for reference.)
While migration to the cloud has a lot of benefits for the adopting organization, it also creates new security problems. Gone are the days when a simple firewall and antivirus software package kept a personal computer safe. These days, entire systems hosted on huge data centers that are running computations for millions of devices need to be secured. That's where Palo Alto Networks comes in.
The company has emerged as a security leader, especially in the burgeoning cloud space where it creates enterprise solutions to secure increasingly complex operations. In March 2018, Palo Alto Networks acquired cloud security specialist Evident.io for $300 million. Now it's RedLock, another cloud security firm, which Palo Alto will pay $173 million to acquire. The two companies will combine to create a new cloud security offering available in early 2019.
Why it matters to investors
Palo Alto already serves more than 6,000 cloud-based customers around the world. Adding RedLock is less about adding new customers and more about making its technology products better for the customers it already has. The RedLock management team comes with the deal. That's an important move as the cyber security space continues to develop and is in line with new CEO Nikesh Arora's comments during the fiscal fourth-quarter 2018 report about making acquisitions that solve customer problems.
Nevertheless, acquisitions like RedLock also need to help sales momentum. Palo Alto has been growing by double digits for years; revenue increased 29% year over year in the most recent fiscal year. As it still operated at a $129 million loss (on an unadjusted basis) in the last 12 months, Palo Alto fetches a $20 billion market cap on the assumption that the double-digit top-line rate will continue.
At some point, though, Palo Alto's operations need to start running a profit. Arora -- a former executive at Alphabet's Google -- plans on overseeing that transition from all-out growth to profitable growth. While RedLock's cloud tech could help bolster overall product strength, combining it with another small subsidiary could help reach both scale and profitability.
How soon that happens remains to be seen, but management said to expect 25% to 27% year-over-year revenue growth during its 2019 fiscal first quarter and continued progress growing free cash flow -- money left over after basic operations and capital expenditures are paid for. For investors worried over lack of net income, Palo Alto Networks' price to free cash flow currently sits at 21.9. Given the company's continued expansion in the nascent but increasingly important cybersecurity sector, that seems like a decent price to pay for those with a long-term outlook.