Shorting Palo Alto Networks Inc. ($52) - Part 2
Mod Note (Andy): See Part 1 Here
Examining PANW's revenue and interesting timing - what's special about July?
• PANW’s own sec filings are opaque with respect to revenue generation and recurrence. PANW’s markets itself as a game-changer, with the implication that it can pull and retain clients from existing competitors such as CHKP. Yet the revenue and (lack of renewal) data do not support this.
o Services after the initial sale is only 1 year, and PANW admits it cannot predict renewal rates – is PANW’s customer base churning? Even after launching their Next-Generation Firewall in 2007 and with 5 years’ worth of data, PANW does not disclose renewal rates:
“…existing end-customers that purchase our subscriptions have no contractual obligation to renew their contracts after the initial contract period, which is typically one year, and we cannot accurately predict renewal rates ”
o Furthermore, their marketing pictures at the top of the recent prospectus “cumulative” end-customer counts, not current/ongoing:
From all this, the question is – how quickly is PANW running through old and new customers? I believe it is far less than the CRM/SaaS like rates, and more like traditional hardware with a far higher churn component.
To be fair, this is a tougher split (cumulative vs. on-going) customers, and the rest of the prospectus doesn’t say cumulative when referring to the 9,000 customer number. Is PANW counting initial appliance buyers (who do not renew) as part of their customers?
o Finally, PANW sells mainly through 3rd party channel partners (distributors/resellers) , and unlike competitors showed a decrease in revenue in a traditionally strong quarter (ending in January 2012).
Again, from the recent prospectus:
"We rely on third-party channel partners to sell substantially all of our products, and if our partners fail to perform, our ability to sell and distribute our products and services will be limited, and our operating results will be harmed."
While not unusual, the lack of detail about these distributors (compared to say CHKP, which breaks out % of top 10 ) and the relative opaqueness invites “stuffing” of the distributors, where PANW ships excessive product in one quarter (or more) to artificially inflate revenues. This is similar to the M. Block/GMCR relationship shown by Greenlight .
To be fair, I have not found direct evidence of the above, but when we look at sales on a quarter-by-quarter (from a Forbes article ), we see that PANW had weaker sales in a traditionally strong quarter for its competitors:
Q3 2011 Q4 2011
Check Point 310.00 356.68
change (qoq) 0.55% 13.09%
Fortinet 103.00 116.40
change 9.42% 11.51%
SourceFire 36.16 53.20
change 42.31% 32.03%
Palo Alto Networks 57.11 56.68
change 29.57% -0.76%
The reasoning is that companies push their sales force to sell at year-end, boosting sales. Yet, PANW is unable to grow/compete? This seems to be on purpose, as PANW is the only company among its major competitors (above) that has a year-end not in December (PANW’s in July, around its IPO).
That begs the question – did PANW purposely go public in July and have a July fiscal year-end to gloss over their December weakness and instead focus on temporarily strong year-over-year comparisons?
Comments
Weak thesis. You can't just
Weak thesis. You can't just short on opacity. By your logic, AMZN is--and has been--a short (good luck getting much info out of them).
What about secular industry trends? Security spending in enterprise is exploding and PAWN has a best-in-class offering.
What about channel checks on what customers think of the product? How do sales trends look? Where's their growth coming from? Is it sustainable?
Many more questions to ask... but most importantly, why is it a short now? Let's say you're right... the thing could be $100+ next year and your PM will be screaming at you, wondering why the fuck you shorted something without having a path to getting paid.
Edit: full disclosure, I've never actually looked at the business in detail myself... just questions that popped up after reading this
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DontMakeMeShortYou: Weak
Weak thesis. You can't just short on opacity. By your logic, AMZN is--and has been--a short (good luck getting much info out of them).
What about secular industry trends? Security spending in enterprise is exploding and PAWN has a best-in-class offering.
What about channel checks on what customers think of the product? How do sales trends look? Where's their growth coming from? Is it sustainable?
Many more questions to ask... but most importantly, why is it a short now? Let's say you're right... the thing could be $100+ next year and your PM will be screaming at you, wondering why the fuck you shorted something without having a path to getting paid.
Edit: full disclosure, I've never actually looked at the business in detail myself... just questions that popped up after reading this
Kind of agree here with DontMake...not sure if these blog posts allow a full blown short thesis to be developed...think there either needs to be linking to prior posts that relate to this and/or a preview of what is to come.
Standing alone, I wouldn't short a stock on hypotheticals on what they might be doing...
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Valid concerns, high
Valid concerns, high valuations, but very art history major type of thinking.
1. It is a game changer from a technical standpoint.
2. Service contracts is not the same as product revenue and usually grows at a different pace. And deferred revenue line usually gives a better read.
3. Once deployed, virtual or physical appliance, it'll be there running until replaced. And there's not that many alternatives compare to Palo Alto. It does not share the same business model as CRM or other SaaS venders...
4. Channel partners, they don't stock much inventories for appliances. Disclosing it would not really help if its just Avnet and Arrow. Can't exactly stuff appliance channels like how GM stuffed their shit
4.5. Palo Alto Networks is not selling traditional firewalls so it cannot be easily compared with legacy venders. And the telecom/networking equipment business is very lumpy.
5. No one can hide a quarter's weakness by shifting fiscal years around let along actually shifting fiscal year on the book... And Palo Alto Networks is not the only networking equipments company that has a non-calendar quarter/year.
How much tech background do you have to understand PANW's technology advantage and who have you spoke with inside the industry? Enterprise networking is a hot segment right now with people getting acquired left/right, i.e., Meraki by CSCO last night, Nicira by VMW, etc, PANW as the market leader in networking security 2.0 is a hot target as well.
That being said, valuation is definitely lofty but they probably will pump out a decent number on 12/6 to promote an orderly unload.
You might be right on the
You might be right on the short, but for the wrong reasons. PANW is crushing it right now (per conversations w/ their major resellers).
PANW will probably pullback on the secondary and when the lock-ups expire. This pattern has held true for other high growth enterprise names like SPLK, GWRE, and NOW.
High valuation also presents little margin for error. If a quarter is a little light PANW will pull back.
I disagree with vitaminc on PANW's differentiation, they are probably 9 months ahead of their competitors right now. The next big growth segment in enterprise security won't be network firewalls, it will be data security. Security as a whole is really hot right now, both stock wise and end-market wise.
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Thank you for the criticisms!
Thank you for the criticisms! Yes, will absolutely agree much more work to be done, and not meant to be the end-all-be-all post. I'll try to address the concerns above:
Dontmakemeshortyou:
Opacity - agreed, as part 2 this is only a supporting part of the thesis, and as for AMZN counter-example, easier to short at 14x revs vs 2-3x ttm of AMZN, and if we look at AMZN post ipo & bubble at 2000, it was trading at ~18x ttm revenues ( back of envelope calc (67 price at 2000 year start /229 price now)*104B mkt cap now)/1.639839 1999 revenues from old 10k). It then proceeded to drop 75% in the next year, despite very much being a game-changer in the book/retailing industry (& beyond). This is very much a cherry-picked example, but Is possible, and given the similar valuation, probable. (http://www.sec.gov/Archives/edgar/data/1018724/000...)
Industry trends - from first post (thank you Andy for linking), noted that from PANW's own offering prospectus this past month implied a 7-8% p/a growth in their core market.
its market (self-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))
(Sources: Prospectus pursuant to Rule 424(b)(4), October 17, 2012, page 2 , http://www.websense.com/assets/white-papers/IDC_We...)
Channel checks/product: big weak point of thesis- reviews are fairly positive on the product from public sources, and I will be first to admit not an expert on the area. However, a far more knowledgeable article from Richard Stiennon, former Chief Marketing Officer of Fortinet, points to the disadvantages of PANW products (namely, lower performance) that are driving customers to use PANW behind, rather than in place of traditional products.
(http://www.forbes.com/sites/richardstiennon/2012/0...)
Timing: will be in next part, but key point is, in the last 3 months, insiders have sold more than 1 year's worth of revenue. Insiders seem in such a hurry as to do a secondary offering 4 months after ipo (http://www.sec.gov/Archives/edgar/data/1327567/000...). This can't be for more growth, as no $ flows to company. If there is even a modicum of faith in the company, why not gradually sell vs a full shot now?
Vitaminc:
Game changer - see channel checks article. The ability to monitor products vs ports (e.g. flow monitoring) has been around (Lancope/Arbor networks), and it seems that is what many of PANW's clients are mainly using it for.
Service contracts - agreed, not same as product revenue. It seems like PANW gets revenue from the sale of their applicance(s) and then the service after. PANW looks to be becoming more dependent on such service contracts, however. and because customers delay/drag out contract without penalty, can at the very least make defferred revenue misleading. Nonetheless, deferred revenue doubled, similarly to revenues yoy (67mm last year july q vs 135mm in july's quarter), so it does match revenue.
Lack of alternatives - see channel checks article again for some companies are using PANW behind their own firewalls, so they can coexist. The initial outlay/dumping of old equipment does introduce stickiness, agreed - but as it is Not SaaS like CRM, I see that as disadvantage because of CRM's crazy revenue recurrence (80-90%, I believe, from Zack Buckley's presentation about SPLK). If PANW is like CRM in that way, would be huge hit to this thesis.
Channel partners: fair enough, not as familiar with this topic. Does dent the revenue massaging argument, and will look for more info on this.
Not a traditional firewall/lumpiness - that has been their pitch since the beginning, and is at the core of this product critique here. Will investigate more.
Calendar: I don't think they are hiding it as much as shifting the focus - you see the last quarter or two & year-end and don't see calendar year-end. The three closest comparisons, CHKP, FIRE, FTNT all have 12/31 fiscal year-ends. By itself, not too meaningful, agreed. But combined with the insiders selling mentioned above (and talked about next post), think there is a decent chance something of the type is happening.
Re: acquisitions, 1) PANW is not cloud-based/SaaS offering - they are actually installing software/hardware locally, with updates, so it not like the cloud-like acquisitions above. 2) valuation: meriko was acquired at ~15ttm revenues, PANW is at 14-15ttm revenues already. Can't find revenue figures for Nicira, but it is interesting to note that they are headed in the opposite direction from PANW no? - PANW delivers its software through hardware, while Nicira attempts to split software from hardware in networking.
EfferCore:
Perhaps! Very possible I will have egg on my face, especially given propensity of these tech stocks to pop right after a s&p bottom. The lock-up/share sell itself liquidity-wise, I feel may have been priced in. As FB's 15%+ pop has shown, not as reliable as some may think!
Further criticism welcome! Will try not to get too attached to this idea, and be comfortable with ditching if holes continue to show up in argument.
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