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Watch Zscaler's Next Big Growth Opportunity

By Herve Blandin – Sep 14, 2021 at 6:55AM

Key Points

  • Zscaler's core offering contributed to better-than-expected fiscal fourth-quarter results.
  • The company is leveraging its technology to update its portfolio and capture its next growth opportunity.

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The cybersecurity specialist is expanding its portfolio beyond end-user protection capabilities.

Given the challenges of securing the computing environments of increasingly mobile employees, the demand for Zscaler's (ZS -1.37%) flagship cloud-based end-user protection products should remain strong over the long term.

Yet the cybersecurity specialist's stock price declined by more than 3% after the publication of better-than-expected fiscal fourth-quarter results and upbeat full-year guidance. That's most likely because the company's rich valuation was already pricing in outstanding performance. 

The good news for shareholders is that Zscaler is eyeing a significant growth opportunity that could send its stock price higher. Let's dig in.

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A disruptive cloud-native cybersecurity platform

Over the last several years, Zscaler has been developing a disruptive cloud-native platform that protects remote workers' computing environments without requiring enterprises to implement, configure, and maintain cumbersome on-premises infrastructure. After installing a client on their laptop or PC, users securely access online resources via Zscaler's cloud infrastructure from anywhere. More recently, the company leveraged its platform to allow secure access to private on-premises applications, too.

The research specialist Gartner has recognized Zscaler's competitive advantage. It positioned the company as the only leader -- far away from its competitors -- in terms of ability to execute and completeness of vision in its October 2020 Magic Quadrant for Secure Web Gateways.

And with the broader adoption of hybrid working environments, boosted by the coronavirus pandemic, Zscaler posted outstanding results during its fiscal fourth quarter, ending on July 31. Revenue increased 57% year over year to $197.1 million. And management anticipates full-year revenue to land in the range of $940 million to $950 million, which corresponds to an impressive 40% growth at the midpoint.

Yet the stock price declined after the publication of such impressive results. Indeed, with a lofty forward price-to-sales ratio of 42, the market was already pricing in a phenomenal performance.

A new big growth opportunity

Fortunately for shareholders, Zscaler is expanding its core business with an extra significant growth opportunity. In addition to securing end-users' working environments, it announced last year new capabilities that leverage its existing infrastructure and technology to secure cloud applications and workloads with its new Zscaler Cloud Protection (ZCP) offering.

For instance, ZCP protects application-to-application communications (micro-segmentation) and detects cloud misconfigurations (cloud security posture). Looking ahead, I expect Zscaler to enrich its cloud app protection platform to address emerging technologies that leverage cloud environments such as 5G, Internet of Things, and edge computing.

Overall, the market for protecting apps and workloads seems large. Management calculated the company's serviceable market at $23 billion.

But more importantly, that market should expand over the long term as enterprises keep moving some of their on-premises applications and infrastructure to the cloud. As an illustration, the application delivery specialist F5 Networks estimated last year that the number of cloud applications instances by servers will increase from 670 million in 2020 to 1.69 billion in 2023, which corresponds to a compound annual growth rate of 36% during that time frame.

During the earnings call, CEO Jay Chaudhry highlighted that ZCP accumulated more than 300 new and existing customers. That remains modest compared to the company's total number of customers above 5,600 at the end of July. But the growth opportunity is materializing off that small base to become increasingly important to the company's business. According to management, emerging products, which include ZCP, should contribute a "low-teens percentage" of new and upsell business in fiscal 2022, up from "high-single digits" during the fiscal fourth quarter.

Looking forward

On the cautious side, investors should note that prioritizing such strong growth opportunities should delay the company's profitability goal of reaching a non-GAAP (adjusted) operating margin of 20% to 22% by 2024, as CFO Remo Canessa discussed during the earnings call. 

Also, such a large and growing cloud app protection opportunity is already attracting some aggressive competitors. For instance, the high-growth cybersecurity specialist CrowdStrike expanded its core endpoint protection business to secure workloads, too.

In any case, if Zscaler keeps executing well on its new cloud app protection initiatives, shareholders could see the stock reach new all-time highs over the long term despite the company's current valuation.

Herve Blandin has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends CrowdStrike Holdings, Inc. and Zscaler. The Motley Fool recommends Gartner. The Motley Fool has a disclosure policy.

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