Palo Alto Networks (NYSE:PANW) did something unprecedented when it released its fiscal 2019 fourth-quarter results earlier this month. The cybersecurity specialist issued a three-year outlook to let investors know that it can keep growing at a nice clip.
Investors bought into the company's vision and the stock jumped nearly 6% the following day despite Palo Alto's calling for earnings between $5 and $5.10 per share for the current fiscal year. This was way below the $6.25 per share consensus estimate from analysts who follow the stock, but Palo Alto management rescued the situation masterfully.
But does it make sense for investors to bet on Palo Alto Networks stock based on the three-year outlook?
Palo Alto's acquisitions should pay off
Palo Alto Networks has made a slew of acquisitions in recent quarters to ensure that it is present in as many cybersecurity verticals as possible. In fact, Palo Alto has acquired seven companies since the beginning of 2018, with four of those acquisitions coming in 2019.
The company says that it takes around nine months to integrate an acquired company into Palo Alto's fabric. During this time, Palo Alto kicks off the "go-to-market strategy" and tries to achieve a 30% to 40% improvement in the original financial targets that it had set when making the acquisition.
The second stage, which extends from nine months to two years, involves boosting the go-to-market capability of the acquired company. During this stage, Palo Alto tries to achieve a 100% improvement over the original financial plan so that the acquisition leads to greater cost synergies.
The third stage, which arrives after the completion of the first two years, is when Palo Alto plans for the acquisition to be accretive, adding value. There are two companies currently in the third stage, while a total of six companies are in the first two stages. So in three years, all of those companies should be in stage three.
The company says that its adjusted operating margin will increase from 22% in the recently concluded fiscal year to more than 25% in the long run.
Moreover, it expects its free cash flow in 2022 to hit $4 billion, which is significantly higher than the $1.58 billion a couple of Wall Street analysts were forecasting. Revenue in fiscal 2022 is expected to hit $5 billion, which is ahead of the $4.3 billion consensus estimate of four analysts.
So Palo Alto's three-year guidance ticks all the boxes, and it should be able to walk the talk provided its acquisitions click. But the outlook doesn't guarantee that Palo Alto stock will continue climbing through the next three years.
But it's a tough industry
Cybersecurity is a competitive industry, so we can assume that Palo Alto is not done with its acquisition spree. The company has time and again resorted to buying smaller players so that it can compete effectively against bigger players.
However, new acquisitions could create new obstacles for Palo Alto if the integration doesn't go according to plan.
That's probably why Palo Alto has already warned investors that its adjusted operating margin will be in the range of 21% to 22% over the next three years. This means that the company doesn't expect any margin appreciation over the forecast period as Palo Alto's fiscal 2019 adjusted operating margin was 22%.
There will be uncertainty along the way and Palo Alto's results are likely to be affected by macro events such as the trade war and acquisition costs. So investors should keep a close watch on the company's key metrics, as failure to meet its targets could send the stock the wrong way.