Cybersecurity selloff follows Palo Alto change in go-to market strategy

Shares of Palo Alto Networks (PANW) are under pressure after the company reported better-than-expected quarterly results but guided to slower year-over-year growth in total billings and revenue amid softer client spending and steep promotions. Rivals Zscaler (ZS) and Crowdstrike (CRWD) fell more than 10% each following the news.

RESULTS: On Wednesday after market close, Palo Alto Networks reported second quarter adjusted earnings per share of $1.46 and revenue of $2B, both better than the expected $1.30 and $1.97B. However, the company said it sees third quarter earnings per share between $1.24-$1.26 and revenue for the quarter between $1.95B-$1.98B, which were weaker than the expected $1.29 and $2.04B. Palo Alto further said it sees third quarter total billings in the range of $2.3B-$2.35B, representing year-over-year growth of between 2% and 4%.

For 2024, the cybersecurity company said it sees adjusted EPS of $5.45-$5.55, up from $5.40-$5.53, with consensus at $5.51. However, it lowered its full year 2024 revenue view to $7.95B-$8B from $8.15B-$8.20B, considerably less than the expected $8.19B. Palo Alto also said it sees 2024 total billings in the range of $10.1B-$10.2B, representing year-over-year growth of between 10% and 11%.  This is down from last quarter’s guidance for 2024 total billings of $10.7B=$10.8B.

‘SIGNIFICANT’ GO-TO-MARKET CHANGE: Following the company’s earnings report, Loop Capital downgraded Palo Alto Networks to Hold from Buy with an unchanged price target of $300. The company reported “another lackluster quarter” amid softness in the U.S. federal government channel and dropped a “significant change” to its go-to-market strategy, the firm tells investors. Loop Capital says Palo Alto essentially introduced a heavy up-front discount program that provides credits to a customer switching out of a competitor’s product.

It appears the company plans to publicly roll out this practice at scale such that it will negatively impact its billings and revenue growth over the next 12-18 months, the firm notes. Loop believes other competitors will have no choice but to match Palo Alto’s move, which would likely dampen the positive effect Palo Alto is hoping for. While positive about the company’s long-term product strategy and current competitive position, the firm finds it prudent to “stay on the sideline at least during the initial phase of the new go-to-market motion.”

Piper Sandler also downgraded Palo Alto Networks to Neutral from Overweight with a price target of $300, down from $350. The company’s results for the third quarter in a row “are creating a large degree of investor consternation,” the firm tells investors in a post-earnings research note. Piper says Palo Alto is the largest platform player in the segment and, in hopes of accelerating that positioning, will take an aggressive approach in offering free product with the promise of longer-term, platform contracts. This should negatively impact the business for 12-18 months, eliminating $600M from billings estimates in the back half of this year, adds Piper. It believes this will have a negative impact on both growth rates and the stock’s multiple in the short to medium term.

Loop and Piper were not the only Wall Street firms to move to the sidelines on Palo Alto. Northland cut its rating on the name to Market Perform from Outperform with an unchanged price target of $275. April quarter billings guidance came in 1300 basis points below consensus, which embeds federal continues to underperform prior expectations and layers in the near-term negative impact of platformization, says the firm. Northland does not believe there is material risk of not realizing re-acceleration to 18%-plus growth rates due to activating platformization acceleration strategy, but is lowering its rating following the strong stock performance.

Rosenblatt also downgraded Palo Alto Networks to Neutral from Buy with a price target of $265, down from $290, following management’s reveal of a mid-quarter strategic adjustment resulting in lower-than-anticipated billings and revenue forecasts. The company, which cites customer spending fatigue and the growing prioritization of solutions with demonstrable ROI as driving factors behind its “course correction,” is strategically pivoting towards platformization, consolidation, and AI leadership, but this shift raises concerns about the potential for a slower path to achieving the company’s goals, the firm tells investors.

TARGET CUTS: Several Wall Street firms lowered their price targets on Palo Alto’s shares on Wednesday, including Barclays, Jefferies, Oppenheimer, TD Cowen, Mizuho, Baird, BTIG, Scotiabank, BMO Capital, Stifel, Morgan Stanley, KeyBanc, Wells Fargo, RBC Capital, Truist, BofA, Bernstein, and Wedbush.  The latter said that Tuesday night “will go down as a brutal night to forget for the bulls (and us)” as Palo Alto lowered guidance for full year 2024 with billings headwinds now abound as Nikesh and the team transition to the next phase of the growth story with the platform approach front and center.

PRICE ACTION: In Wednesday morning trading, shares of Palo Alto have dropped over 26% to $270.19. Also lower, Zscaler has slipped about 15% to $211.87, while Crowdstrike has slid about 10% to $291.30. Shares of Cyberark Software (CYBR) have also dropped more than 4% to $239.85. Other publicly traded companies in the cybersecurity space include Check Point (CHKP), F5 Networks (FFIV), Fortinet (FTNT), Okta (OKTA), Qualys (QLYS) and SentinelOne (S).