Cybersecurity company Palo Alto Networks (PANW 0.91%) stock flourished earlier this year, with shares reaching a 52-week high of $380.84 on Feb. 9. Then on Feb. 20, the company released results for its fiscal second quarter (ended Jan. 31) and its stock price promptly plunged.
Shares remain well below the 52-week high at the time of this writing. Does this share price drop provide a buying opportunity? Or is this a warning sign not to invest in Palo Alto Networks?
To answer that question, it's necessary to examine the company in more detail. And digging into why Palo Alto Networks stock plummeted can help to assess if the firm makes for a good long-term investment.
Why Palo Alto Networks stock dropped
Several factors played into the price drop of Palo Alto Networks stock. One is softness in U.S. government spending. CFO Dipak Golechha noted, "This U.S. federal weakness was a meaningful headwind to our billings in Q2."
Yet perhaps the most significant factor is increased scrutiny among businesses regarding cybersecurity spending. As CEO Nikesh Arora described it, "The part that is new, despite the many demand drivers we're seeing, we're beginning to notice customers are facing spending fatigue in cybersecurity."
Palo Alto Networks management noted that most of its customers were spending more on cybersecurity than on IT. This has led customers to question how to lower their spending on cyber threat protection products.
Palo Alto Networks sees an opportunity in this trend, and decided to make a strategic shift in its business this year to capitalize on it.
The company will now pursue customers by incentivizing them to move away from using multiple cybersecurity vendors, and consolidate their security needs onto the Palo Alto Networks platform. In this way, customers can reduce overall cybersecurity costs.
To facilitate this, the company announced it would charge no fees while a customer transitions from an existing cybersecurity vendor to Palo Alto Networks. This aggressive approach to acquiring customers means the company anticipates its revenue will take a hit in the short term. That's understandable since Palo Alto Networks is taking on customers without charging them for a period of time.
This period of reduced income is estimated to span the next 12 to 18 months. As a result, the company revised its fiscal 2024 forecast down from at least $8.15 billion in revenue to a minimum of $7.95 billion. This change in forecast revenue also contributed to the decline in Palo Alto Networks stock.
The upside of Palo Alto Networks' new strategy
Despite the short-term impact to Palo Alto Networks revenue, the company's management team feels confident the new strategy will work over the long run. Arora stated, "We believe we can build customer confidence in our platforms by approaching them well before their point product contracts expire."
This strategy will lead to substantial growth in annualized recurring revenue (ARR) over the long run, according to Palo Alto Networks management. ARR measures the total revenue the company stands to collect from its customer contracts over an annual period.
Here's how Palo Alto Networks sees ARR growth playing out. For fiscal 2024, the company forecast ARR to reach at least $3.95 billion. With the new strategy the company introduced, Palo Alto Networks expects to grow ARR to $15 billion by 2030.
The company appears capable of achieving this substantial revenue growth. Since Arora took over as CEO in 2018, the company has ridden a rocket ship of rapidly rising revenue.
Data by YCharts.
This trend continues today. In its fiscal Q2, Palo Alto Networks revenue reached $2 billion, a 19% year-over-year increase. It estimates fiscal Q3 revenue to hit at least $1.95 billion, up from $1.7 billion in the previous year.
Deciding whether to buy Palo Alto Networks stock
Palo Alto Networks revenue might be impacted in the short term on its path to long-term revenue growth. Yet even with its reduced guidance, the company's anticipated 2024 fiscal year sales of at least $7.95 billion remains a double-digit increase from the prior year's $6.9 billion.
In addition, Palo Alto Networks' ability to produce free cash flow (FCF) is solid. Through the first half of fiscal 2024, Palo Alto Networks generated $2.1 billion in FCF, up from $1.9 billion in the prior year.
Another point to consider in assessing Palo Alto Networks stock is the insight provided by Wall Street analysts. They believe the company's stock will go up, with a median share price target of $335.
If you combine this with the company's consistent revenue growth, solid FCF generation, and aggressive customer acquisition strategy, Palo Alto stock looks like a worthwhile long-term investment.
