Zscaler (ZS 1.28%) stock plunged in Wednesday trading on news that Microsoft (MSFT 1.82%) has added a suite of cybersecurity products to Microsoft Entra. This directly affects Zscaler, as Microsoft Entra Private Access includes a zero-trust solution.
However, in selling Zscaler stock, investors seemed to have ignored the state of the cybersecurity industry, specifically zero-trust products. Such an oversight could lead to a unique buying opportunity in Zscaler stock.
So what happened?
Zscaler's stock fell by about 12% following the announcement from Microsoft. Indeed, the stock is still up by almost 64% from its May low, so it may have been due for a correction. It also notably began regaining momentum the next day.
Having a competitor like Microsoft is scary for any growth stock. Zscaler's market cap of about $20 billion is less than 1% of the size of Microsoft's, which has now reached about $2.5 trillion.
Also, with over $104 billion in liquidity, Microsoft has the funds to compete in this industry at the level it chooses. Even though Microsoft sells products in many segments of the software business, this zero-trust focus is concerning for Zscaler, which is not likely to turn generally accepted accounting principles (GAAP) profitable anytime soon.
Why Zscaler may still be in good shape
However, investors should not assume that Microsoft can or will buy success in this industry. Zscaler was the first company to sell a zero-trust security suite delivered within the cloud. This has given Zscaler a first-mover advantage since introducing this product in 2016.
Investors might also forget that cybersecurity, including the zero-trust part of the business, has long remained competitive. Zscaler's list of other competitors includes Palo Alto Networks, CrowdStrike, Okta, IBM, and numerous others. Hence, how Microsoft will fare against Zscaler and these other zero-trust products remains unclear.
Moreover, these companies are likely acting on the industry's massive growth potential. Allied Market Research forecasts the zero-trust part of the market alone will reach $126 billion by 2031. This amounts to a compound annual growth rate (CAGR) of almost 19% over the next eight years.
Zscaler's financials
Furthermore, Zscaler has barely begun to serve this market, and its growth rate far exceeds the industry's CAGR. In the first nine months of fiscal 2023 (ended April 30), revenue of $1.2 billion rose 50% versus the same period in fiscal 2022.
Indeed, its $332 million in stock-based compensation expenses and related payroll taxes led to an operating loss. Still, the net loss for the period fell to $172 million versus $293 million in the same period in fiscal 2022.
Also, despite the recent price action, Zscaler has not recovered from its declines from the 2022 bear market. And thanks to that drop and its rapid growth, its sales valuation is near historic lows despite a price-to-sales (P/S) ratio of 14. This indicates a possible buying opportunity as some of the pessimism exits the market.
Stay the course on Zscaler
In the end, it is unlikely that Microsoft's entry into this business with materially change Zscaler's investment thesis. Indeed, attracting such a powerful rival as Microsoft could cause concerns. However, Microsoft is just one of many competitors.
Moreover, the industry is poised for massive growth, and the cybersecurity stock has exceeded that growth rate despite its numerous peers. With revenue growing at 50% and a sales multiple near all-time lows, Zscaler's investors still have more reasons to buy than sell.
