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Zscaler Gets Punished as the Cloud Security War Heats Up

By Nicholas Rossolillo – Sep 12, 2019 at 5:04PM

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The cybersecurity company put the final touches on a successful fiscal 2019 outing, but stock investors didn't seem all that impressed.

The tides seem to have changed a bit for Zscaler (ZS 3.74%) -- at least for its stock anyway. Shares are down about 20% this week after the company reported on its fiscal 2019 fourth quarter, even though results topped guidance and fiscal 2020 forecasts suggest the company expects to yield more big upside numbers.

Part of the issue could be that the cybersecurity outfit's valuation has gotten way out of hand as shares had more than doubled in price from the start of 2019 to early August. So some healthy skepticism was overdue.

And the battle over next-gen cybersecurity has involved some verbal jabs and trolling of the competition lately during quarterly updates, but it doesn't mean Zscaler's business has problems. All indications are that it is actually doing just fine.

Summing up fiscal year 2019

By nearly all counts, the last year was a good one for Zscaler. Cloud computing is a booming segment of the tech industry and keeping that business data safe is getting more complicated. That's good news for cloud-native outfits like Zscaler that don't depend on network hardware to keep everything on lockdown.

Revenues in the fourth quarter grew 53%, topping guidance given a few months prior, and adjusted net income came in at positive $9.1 million compared with a $1.4 million loss last year. The net dollar-based retention rate was 118%, implying that existing customers spent 18% more than they did last year.  

Paired with the first three quarters of the year, Zscaler put up impressive numbers as it gobbled up a share of the cloud-based cybersecurity industry. Those numbers came complete with a lucrative gross profit margin on services provided that holds the promise of bigger bottom-line gains in the years ahead. 

Metric

12 Months Ended July 31, 2019

12 Months Ended July 31, 2018

Change

Revenue

$303 million

$190 million

59%

Gross profit margin

80.3%

80.1%

0.2 pp

Operating expenses

$278 million

$187 million

49%

Net income (loss)

($28.7 million)

($40.0 million)

N/A

Adjusted earnings (loss) per share

$0.22

($0.23)

N/A

Pp = percentage point. Data source: Zscaler. 

A war of words or real headwinds?

Though it is still one of the largest cybersecurity pure-play stocks out there, Zscaler has taken a serious hit in recent weeks. It and other cloud-native software-defined security upstarts are growing much faster than hybrid-cloud one-stop-shop incumbents like Palo Alto Networks (PANW 3.60%), Fortinet, and the older and now carved-up Symantec. But the competition is nevertheless fierce.

There are other cloud-native security companies out there like still-private iboss, CrowdStrike Holdings, and Okta (OKTA 1.67%) vying for attention. Though Zscaler is still growing north of 50%, it is cooling off a bit, and the crowded playing field likely has something to do with that.

A man in a suit pressing an illustrated icon of a lock.

Image source: Getty Images.

Plus, it's not like the older players in the industry are standing by while this cloud transformation happens. During its last earnings update, Palo Alto Networks CEO Nikesh Arora said that his company displaced Zscaler when bidding for and winning a security contract renewal. Zscaler CEO Jay Chaudhry said he was unaware of losing any large customers and called the recent trolling an act of "desperation." Palo Alto Networks hauled in nearly 10 times the revenue Zscaler did in the last year and is growing at a 20% clip, so it's probably not desperation talking.

At the very least, the jabber-jawing underscores how competitive the landscape has become. At the moment, there's plenty of market demand to go around, but that could change as time goes on. Zscaler, for its part, is working toward the goal of $1 billion in annual sales, with a 20% to 22% operating profit margin. A newer product introduction, Zscaler Private Access -- which integrates with Okta's user identity security -- is its fastest-growing segment, and more product rollouts will inevitably start to step on more toes.  

Nevertheless, for the new 2020 fiscal year, management said to expect 41% to 42% growth in the first quarter, and 30% to 34% growth for the full year. But management also cautioned that it is being prudent in its projections. With Zscaler's plans to invest aggressively in the business to maximize sales growth, there certainly was enough in the fourth-quarter report to keep long-term shareholders happy -- even if the stock weirdly headed south on the news.

Nicholas Rossolillo and his clients owns shares of CrowdStrike Holdings, Inc., Fortinet, Okta, Palo Alto Networks, and Zscaler, Inc. The Motley Fool owns shares of and recommends Okta, Palo Alto Networks, and Zscaler, Inc. The Motley Fool owns shares of CrowdStrike Holdings, Inc. The Motley Fool recommends Fortinet. The Motley Fool has a disclosure policy.

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Stocks Mentioned

Zscaler Stock Quote
Zscaler
ZS
$170.51 (3.74%) $6.14
Palo Alto Networks, Inc. Stock Quote
Palo Alto Networks, Inc.
PANW
$169.69 (3.60%) $5.90
Okta Stock Quote
Okta
OKTA
$57.82 (1.67%) $0.95

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