• Sharebar

mod note (andy): t1254 is a recent graduate who worked briefly at a bulge bracket investment bank before leaving to start a small investment fund. Primary focus is in equity value investing/trading.

Investing is tough, but shorting firewalls here may be a profitable way to do so.

This blog will serve as a journal to keep track of and review ideas for trading and investing. It serves to track an ongoing experiment with regards to investing, namely a strategy where:

1) Valuation is more art than science, less about numbers and more about a few key insights that drive future profitability.

2) Market psychology, in terms of trend-following can provide the timing. In particular, being first doesn't help if a catalyst doesn't show up for many years.

To begin:

Palo Alto Networks,
Inc. (Short @ 54 with 1-year target of 20)
November 9th, 2012
52-week high
Software and
52-week low
(FY ends July)
Earnings per Share
Shares Outstanding (in
Market Cap (in $mm)
Net Debt (in $mm)
EBIT (in $mm)
TEV (in $mm)

*Historical data from company prospectus (Oct 17th, 2012)

Palo Alto Networks, Inc. (PANW) is a newly-public enterprise network security company which is highly overvalued given its highly competitive market, revenue opacity, and excessive insider selling. The market believes PANW’s platform is revolutionary in a growing industry- I believe that the network security business is a highly competitive industry and that PANW has little pricing power. Insiders seem to know this and seem desperate, hence a secondary offering of year’s revenue less than four months after ipo.

Corporate internet security is a highly competitive market that is not growing as quickly as before and is forced to underprice its largest competitor to gain market share. From PANW’s own prospectus, its market (defined as “Network Security market and Web Security ) is expected to grow from $10B in 2012 to $13.4B in 2016 – that’s only 7.59% per annum vs. 11.6% from 2009 to 2010 . Earlier forecasts of 2012-2016 were more optimistic as well, as the market has been lowering expectations

o Despite a next-generation product, PANW’s gross margins are lower than CHKP, its main competitor. Check Point Software Technologies Ltd., the leader in the firewall and UTM (Unified Threat Management) market, the main focus of PANW, has gross margins of 87.6% vs. 72.3%. At a high level, this means that PANW is underpricing CHKP to gain customers.

o Fundamentally, network security is a tail risk market and is therefore underpriced. Like seat belts, internet security is usually a time-waste/drain unless an actual attack/error happens. It is one of those cases where successes are unknown but failures (breaches) can make headlines (e.g. Google servers attacked )

o Internet firewalls and network security face price competition due to mass availability of free-mium model. Free personal firewalls are a dime-a-dozen (see free Avast, Zonealarm), and so only very complex/large corporations require the added power of PANW and are willing to pay for it.

To be continued...


Comments (3)

  • tt1254's picture

    Totally agree re: acquisition risk. Will be addressed more in later parts, but the main counter arguments I see are:

    1) valuation. CRM acquisition of successfactors was at 12.1x ttm rev, while PANW is trading at 13-14x ttm revenues. Yes, growth has been phenomenal (100% yoy rev), but still (http://softwareequitygroup.wordpress.com/2012/04/2...)

    2) different industry - PANW is not a SaaS company and is in a slower segment (appliances) - I do believe there is a fundamental difference between SaaS growth (22%+ accelerating) and security appliance (17%, slowing) (which PANW does). Granted they market themselves as software, but they deliver their services through hardware (ie company has to buy equipment to set up). (growth rates: http://www.websense.com/assets/white-papers/IDC_We...)

    3) insiders - if there were hope, why are they selling en masse (details on later part).

    Still, that is the (irrational) risk!