Cybersecurity has been one of the hottest investment sectors in recent years. Given the number of high-profile cybersecurity attacks and breaches, this probably should not be surprising. For example, the casino industry was hit with attacks on MGM Resorts and Caesars Entertainment last year, while this earlier this year UnitedHealth Group subsidiary Change Healthcare was the victim of a ransomware attack.
Unrelenting cybersecurity attacks across various industries, meanwhile, continue to fuel spending to help thwart and prevent these attacks. One company trying to help prevent these cybersecurity attacks is Zscaler (ZS 1.12%).
While the company is in an attractive industry, the question is, is the stock a buy after its recent dip in price?
Profiting from zero trust
Not all cybersecurity companies are created equal, nor do they focus on the same thing. Zscaler, for example, is largely focused on the area of zero trust. This cybersecurity model is predicated on the idea that no individual users or devices should be trusted, even if they are already on an organization's network. As such, all users must be verified, authorized, and continuously validated.
Zero trust is one of the fastest growing segments in cybersecurity, with global spending expected to increase at a compound annual growth rate (CAGR) of nearly 17% through 2028. For its part, Zscaler saw strong revenue growth of 35% in its most recent quarter, with billings increasing 27%. Billings represents the amount of money a company has billed its customers, and is often a good indicator of future revenue growth.
Within zero trust, Zscaler offers three main solutions for both users and workloads: Zscaler Internet Access (ZIA), Zscaler Private Access (ZPA), and Zscaler Digital Experience (ZDX). ZIA is used to provide secure access to organizations' websites and apps, while ZPA can grant users access without revealing their identities or locations. ZDX, meanwhile, is used to help organizations identify whether a problem could be coming from an internet connection, service provider, or user device.
Image source: Getty Images.
Upselling and large customer growth
One of the biggest strengths that Zscaler has shown has been growing within its customer base. This can be seen in its strong net dollar retention numbers. For its fiscal year ended in July, the company saw net dollar retention of 121%. For its most recent quarter ended in January, this metric was 117%. Net dollar retention measures the amount of revenue coming from existing customers after churn, upgrades, and downgrades. This metric shows that customers are not only staying with Zscaler, but they also continue buying more of its services.
Zscaler does a particularly good job of upselling and bundling solutions to large organizations. The company ended last quarter with 497 customers that spend $1 million or more with it on an annual basis. That was a 31% increase from 378 such customers a year ago, and a 6% sequential increase from 468 customers the prior quarter. The number of customers spending $100,000 or more with the company, meanwhile, increased 21% year over year to 2,820 customers.
Another area the company has done well with is starting to use vertical-specific experts to sell into specific industries. It started this approach last year with the public sector, and expanded into other verticals such as healthcare. The company closed a big healthcare deal to help protect patient records last quarter, and given the recent UnitedHealth Group breach, this looks like it should be a big area of opportunity.
Paying up for growth
From a valuation standpoint, Zscaler is not exactly cheap trading at just over 13 times forward revenue. However, that is a pretty large discount compared to where the stock traded at a couple of years ago.
Zscaler has fallen from its highs due to a few reasons. Its chief operating officer resigned earlier this year, while investors may not have liked a deceleration in its billings growth. The company also reported its quarterly results a few days after cybersecurity company Palo Alto warned it was seeing "spending fatigue," so investors were likely being a bit more critical after its rival's surprise warning. None of these issues, however, should impact the long-term performance of the company.
ZS PS Ratio (Forward) data by YCharts
If Zscaler can continue to grow its revenue between 20% to 30% over the next several years, which looks probable given the projected global growth of zero trust security over the next five years, the stock should more than justify its current valuation. As such, I think Zscaler looks like buy at current levels, as the company should be one of the big winners in cybersecurity over the long run.
