Over the last few quarters, Palo Alto Networks (PANW -28.44%) has been struggling with disappointing results from its legacy hardware-based products. In contrast, the cybersecurity vendor's cloud business is shining. And that trend should continue as the company has plans to increase its exposure to a high-growth cloud-based security market: It recently announced it has signed a definitive agreement to acquire SD-WAN specialist CloudGenix.

Palo Alto Networks needs to develop its cloud-based portfolio

With the development of cloud computing, Palo Alto's legacy products to protect on-site computing infrastructures are becoming less and less relevant. During the last quarter, revenue from the company's product segment, which includes hardware devices such as firewalls and gateways, dropped to $246.5 million, down 9.2% year over year.

In contrast, revenue from the company's subscription and support segment, which includes cloud-based solutions, increased to $570.2 million, up 29.7% year over year, boosted by multiple acquisitions over the last several quarters.

During the last earnings call, management explained that changes in sales incentives caused the underperformance of the legacy business. But in reality, the higher growth opportunities remain in the cloud.

However, despite its large scale (trailing-12-month revenue of $3.1 billion and more than 70,000 customers), Palo Alto may miss some of those growth opportunities since its portfolio doesn't address the whole cloud-based cybersecurity market. For instance, the company doesn't offer an email security solution, and its SD-WAN offering remains modest. 

A hand touching a picture of a cloud with a padlock icon

Image source: Getty Images.

Why SD-WAN is so important

SD-WAN (software-defined wide area network) technology regroups the technologies that allow businesses' remote sites to securely access applications hosted in private data centers or in public clouds.

That technology has become important with the development of public  clouds hosted by third parties. Instead of using an expensive private network to access applications and data hosted in their own data centers, enterprises' remote sites can now securely access cloud-based resources via a cheaper internet connection. 

Given the significant potential savings for a company with multiple remote sites, SD-WAN represents a solid growth opportunity. MarketsandMarkets estimates the SD-WAN market will grow at a compound annual rate of 32.7% through 2023. Palo Alto's competitor Fortinet recently posted strong results partly thanks to its SD-WAN business.

The acquisition of CloudGenix makes sense

Palo Alto's planned acquisition of SD-WAN specialist CloudGenix for roughly $420 million in cash may sound surprising since last quarter Palo Alto announced the release of an internally developed SD-WAN product integrated with its firewalls and cloud access solution Prisma Access.

But the company plans to offer both SD-WAN solutions as they correspond to different needs, which will allow Palo Alto to capture a bigger share of the market. Palo Alto's home-grown stand-alone SD-WAN capabilities address customers who prefer to build and manage their own networks. In contrast, CloudGenix's SD-WAN offering combined with Prisma Access offers a software-as-a-service (SaaS) solution that offloads the complex security and networking processes to the cloud.

Palo Alto Chief Product Officer Lee Klarich said the company plans to connect CloudGenix's SD-WAN directly to Prisma Access. In fact, CloudGenix's solution is already integrated with the cloud infrastructure of several security vendors, including Zscaler, Check Point Software Technologies, and Palo Alto.  

It remains to be seen whether CloudGenix will remain compatible with Palo Alto's competitors' cloud infrastructures. But the fact that CloudGenix's SD-WAN already works with Prisma Access greatly reduces integration risks.

Financial details

Palo Alto agreed to pay approximately $420 million in cash to acquire CloudGenix. With $3.45 billion in cash, cash equivalents, and investments, and $1.5 billion of debt at the end of January, the transaction won't impair the company's solid financial position.

However, the risk that Palo Alto overpays for this acquisition exists. Since the deal is still pending regulatory approvals, management didn't provide extra financial information. Thus, investors should pay close attention to the company's next earnings call at the end of May to get clarity on the financial aspects of that transaction that is expected to close before August.