Cyber threats are a growing concern among the world's top businesses. Technologies like generative artificial intelligence (AI) are helping bad actors craft sophisticated attacks by creating hyper-realistic phishing emails, and voice recordings that can trick employees into handing over sensitive information.
In fact, 64% of the 4,702 CEOs recently surveyed by PwC believe generative AI will increase cybersecurity risk in their organizations over the next 12 months. It was their biggest concern when it comes to AI, outranking the spread of misinformation and potential legal risks.
Advanced cybersecurity tools that use AI to deliver smarter, more automated protection are required to combat these new-age threats -- and Palo Alto Networks (PANW 0.91%) is a leader in that very field, but the stock has had a rough go of it lately.
The company recently released results for its fiscal 2024's second quarter (ended Jan. 31). That sent the shares plunging 29% as the company announced a shift in its business strategy. However, these new steps could bear fruit over the long term. Here's why investors should consider the stock now.
Palo Alto is a leader in AI-based cybersecurity
Palo Alto's business is split into three platforms: network security, cloud security, and security operations. The company is gradually weaving AI through many of the products under those banners to give businesses the most advanced protection possible.
Here's a notable statistic. Palo Alto says 93% of security operations centers within organizations still rely on human-led processes. Cybersecurity managers are under such a heavy workload that 23% of incidents are left uninvestigated, which creates an unacceptable number of vulnerabilities.
Palo Alto's Cortex XSIAM security operations platform was designed to solve that problem. AI and automation are at its core, and for one large customer, it has reduced the number of incidents that require manual investigation by 75%. Another customer now has 90% of their security incidents solved by automation, up from 10% prior to adopting XSIAM. XSIAM was launched a little over one year ago, and it has already amassed a revenue pipeline worth $1 billion.
But the AI opportunity is just heating up. Organizations and their employees will be using AI an increasing amount in the coming years, and Palo Alto says security isn't yet front and center. They could be accessing AI in an insecure manner that places their critical data at risk, and plugging those vulnerabilities could be a $5 billion opportunity by 2030.
Plus, Palo Alto says the frequency of phishing emails has increased 12-fold over the last year because of AI's ability to generate them instantly. According to CrowdStrike, 90% of successful cyberattacks originate at the endpoint -- the computer or device used by each employee -- making it the most vulnerable part of every company.
Phishing emails tend to target those employees, and since Palo Alto already protects roughly 100 million individual users, it has a huge opportunity ahead in limiting the damage.
A strong Q2, but reduced full-year forecast
Palo Alto delivered $2 billion of revenue in the second quarter, marking a 19% increase from the year-ago period. It also delivered $1.46 in non-GAAP (adjusted) earnings per share, which was a 39% increase. Palo Alto was profitable on a generally accepted accounting principles (GAAP) basis, too, although the result benefited from a large one-off income tax benefit.
The point is, this company is delivering revenue growth without substantial losses at the bottom line, unlike many of its competitors, which are still burning through cash each quarter. Palo Alto's remaining performance obligations (RPOs) also soared 22% to $10.8 billion, which typically converts to revenue over time.
However, Palo Alto's management team unexpectedly reduced its forecast for both RPOs and revenue for the fiscal 2024 full year. The company is undergoing a major strategy shift to position itself for accelerated growth in the future.
Image source: Getty Images.
The shift toward platformization
The cybersecurity industry is fragmented, with companies often piecing products together from different providers based on their needs. Historically, Palo Alto has relied on the quality of its products to attract its customers to use more of them.
I mentioned earlier that Palo Alto's business is split into three platforms. Well, the lifetime value of customers using all three platforms is 40 times greater than those using just one. Therefore, incentivizing large customers to use Palo Alto for all of their needs could drive enormous growth in the long term.
The problem is that large organizations often have existing contracts with their cybersecurity providers and can't simply opt out whenever they please. So, Palo Alto is offering them fee-free periods to capture them while they are still contracted with a competitor. Then, once that contact runs out, they will convert into paying customers for Palo Alto.
It's a great strategy that forgoes short-term revenue (hence the drop in billings and revenue guidance) in exchange for potentially significant growth in the long term. Plus, it squeezes out Palo Alto's competitors in the process.
Why Palo Alto stock is a buy now
Palo Alto believes the accelerated shift to platformization will help the company reach $15 billion in annual revenue by 2030, 90% of which will be recurring revenue, creating a stable and reliable business.
Considering that the company expects to deliver $8 billion in revenue during fiscal 2024, hitting that goal would translate to an 87.5% increase between now and then -- or a compound annual growth rate of 11%.
However, Palo Alto thinks there could be upside to its $15 billion target thanks to AI. That isn't surprising given that so many companies developing AI technologies are delivering explosive growth right now. The truth is, nobody knows exactly how much the threat landscape might be altered by sophisticated AI-based attacks, so the true size of Palo Alto's long-term opportunity is hard to discern.
So, while investors rushed for the exits following the reduction in Palo Alto's guidance, the 29% drop in its stock price presents an opportunity for investors who are willing to hold for the long term. They might be glad they bought in when they look back on this moment in a few years, assuming Palo Alto's vision becomes reality.
