There’s no question that Cisco (CSCO) had a rough first quarter. The company struggled in IP routing as the timing of new deliveries weighed on sales growth.
However, excluding this poor performance in IP routing, CSCO performed very well in security technology.
Given what we saw from FireEye (FEYE) a couple weeks ago, the performance from CSCO suggests there may be some value plays in cybersecurity stocks, such as Palo Alto Networks (PANW).
Breakdown in Cybersecurity Shares
FireEye has been a Wall Street favorite among cybersecurity stocks for the last couple years. However, sentiment for the entire industry took a step back this month when FEYE’s Q3 billings growth of 28% and its product revenue growth of only 24% significantly underperformed overall revenue growth of 45%.
For cybersecurity stocks, billings and product revenue are very important, acting as indicators for subscription revenue and the direction of the company. The fact that FEYE’s billings and product revenue has slowed so much could mean that demand is weakening. As a result, FEYE’s performance has dragged down most cybersecurity stocks.
That said, there is a silver lining of sorts, and that’s Cisco.
CSCO has a more mature security business: not only cybersecurity, but also traditional IP and network-related security products and services. During its last quarter, CSCO’s security sales rose 7% to $485 million, far better than shareholders expected.
In fact, the security space as a whole still looks strong. What’s happening is that the leaders are being separated from the pretenders. The global cybersecurity market is growing fast and will be a $224 billion market by 2022. Companies are all fighting for market share, and who wins will ultimately come down to business processes and strategy.
For example, FireEye’s product offering was particularly appealing during past emergency security spending. FEYE employs a network of two million virtual servers that identify threats and inconsistencies and then share that information across its network. Therefore, when JPMorgan (JPM), Home Depot (HD), Target (TGT) and others were reporting enormous security breaches, FEYE reaped the rewards because its technology could identify what traditional software could not.
However, in a security landscape that’s lacked large-scale public attacks in recent memory, only necessary cybersecurity services have seen consistent growth. And at the end of the day, it is those necessary services that will steal the most market share.
This includes the continuation of rapid spending on next-generation firewalls, along with database and email protection as offered by Palo Alto Networks.
What Makes PANW Special?
While firewalls hardly sound like an exciting business, Palo Alto’s platform was developed with today’s threat in mind, providing next-generation firewalls for mobile devices, the cloud, servers and other physical and virtual workstations.
What makes PANW so attractive is that it already has nearly half (PDF) of the Global 2000 as customers, but the majority of these customers use PANW services in moderation, leaving significant room for PANW to upsell.
Last year, Morgan Stanley (MS) conducted a survey of Chief Security Officers that pegged PANW’s market share as a primary firewall vendor was just 2%. However, MS found that 25% of CSOs planned to use PANW as either their primary or secondary firewall vendor at the time of their next refresh. That was up significantly from the 10% of interviewed CSOs that used PANW at the time.
It’s because of these plans, and the preference of CSOs to add that extra layer of security over traditional firewall service providers that has sparked PANW’s growth in 2016.
Not to mention, 2016 could be even better for PANW than 2015. MS figured that PANW would add 4% to 5% incremental growth from its current customers reaching a refresh cycle this year, but in 2016, that incremental growth could reach 10% as more of PANW’s customers refresh their firewalls.
PANW Stock Looks Golden
With all things considered, it is simple to see why a company like Palo Alto Networks and Cisco would thrive in today’s security environment. FireEye, however, thrives when all hell breaks loose, and is considered more luxury than necessity.
Meanwhile, CSCO is providing the infrastructure for mobile networks, and also the security for these products, along with malware and web security — all of which is a necessity, much like PANW with firewalls.
That said, CSCO is a diversified company where security is just one small piece of the puzzle, and it has problems in businesses that are much more significant for the company.
However, PANW is 17% off its 52-week highs, and given Morgan Stanley’s research coupled with CSCO’s performance and the overall outlook for cybersecurity stocks in general, PANW looks like a great investment opportunity.
As of this writing, Brian Nichols did not hold a position in any of the aforementioned securities, but may initiate a long position in PANW.
