Mid-Year Cybersecurity Review: Part 1

In 2024, the cybersecurity sector has shown significant promise, driven by advancements in AI and an increasing need for robust digital protection.

Broad-based strength is evident as companies like Palo Alto Networks, whose next-gen solutions grew 47% on a base of $3.8 billion and Cloudflare, which reported 31% growth, delivered strong results despite initial investor disappointment.^1,2 Notable rising starts include CrowdStrike and Zscaler, both reporting revenue growth exceeding 30%, with CrowdStrike’s revenue at ~$3.3 billion and Zscaler’s at ~$2 billion in the last twelve months.^3,4 Challenges remain for some, such as SentinelOne, which delivered industry-leading 40% growth but faces scrutiny for profitable growth and Okta, which reported better-than-expected earnings but struggles with long-term growth and margin expectations.

Nevertheless, cybersecurity has become a staple business expense, essential for protecting against escalating threats. The recent pullback in cybersecurity stocks, with many down 20-30%, presents a compelling buying opportunity.⁵ As the technology rally broadens beyond the narrow focus on AI, these stocks are poised for recovery and growth. The rise in ransomware attacks, now affecting over 10% of organisations, underscores the urgent need for robust cybersecurity measures. Investing in cybersecurity now, whether upgrading existing infrastructure or building new systems, is crucial to meeting these demands and capitalising on future growth prospects.

In this Part 1 of our Mid-Year Cybersecurity Review, we explore the most recent earnings season for Palo Alto Networks, CrowdStrike and Zscaler before outlining the key trends and factors shaping the sector’s outlook in Part 2.

Palo Alto Networks: The Tortoise’s Patience, the Bull’s Strength⁶

Palo Alto Networks, the world’s largest pure play cybersecurity firm, has faced a tough year, cutting its Fiscal Year 2024 billings forecast by $600 million. Despite this, the company’s strategy of ‘platformisation’ and aiming to be a comprehensive security solution is reflected in its rapid advancement in Next-Gen Security (NGS). This encompasses cloud-delivered security services like Prisma Access (SASE), Prisma Cloud (cloud security) and Cortex (security operations).

Source: App Economy Insights 2024

Key metrics in Q3 Fiscal Year 2024 (ending in April):

• Revenue grew 15% Y/Y to $2.0 billion ($10 million beat).
• Operating margin was 9% (+4pp Y/Y).
• Adjusted EPS was $1.32 ($0.07 beat).

Noteworthy items:

• Annual Recurring Revenue (ARR) for NGS grew by 47% year-over-year to $3.8 billion, with a 9% sequential increase. This growth is expected to boost subscription revenue over time. CEO Nikesh Arora expressed confidence in achieving $15 billion in NGS ARR.
• Fiscal Year 2024 billings are expected to grow 10% to 11%
• Some customers have opted for deferred payments, which has affected short-term billings growth, but this trend is expected to stabilise over time.

Overall: Despite concerns over the slowdown in billings growth, Palo Alto Networks continues to demonstrate strong performance in its NGS offerings. The company has maintained operating leverage over the past nine quarters and has revised its mid-range earnings per share (EPS) forecast for Fiscal Year 2024 to $5.57, up from the previous estimate of $5.50.

CrowdStrike: Defying Macro Gravity⁷

CrowdStrike has distinguished itself in the software and cybersecurity space by delivering strong results amid challenging macroeconomic conditions. The company’s focus on cloud-native solutions and advanced threat intelligence continues to drive significant growth and market differentiation.

Key metrics in Q1 Fiscal Year 2024:

• Revenue grew 33% Y/Y to $921 million, surpassing consensus expectations by 2%.
• Operating income increased 72% Y/Y to $199 million, with an operating margin of 22%, up from 17% in the prior year.
• Free Cash Flow increased 42% Y/Y to $322 million. CrowdStrike has a 35% free cash flow margin and a rule of 40 score of 68 (!).
• Diluted EPS was $0.93, growing 63% Y/Y and beating consensus by 4%.

Noteworthy items:

• Net New ARR grew 22% in Q1 to $212 million, while ending ARR grew 33% Y/Y to $3.65 billion.
• Gross Margins reached a record high of 78%, up 26 basis points Y/Y, due to investments in data centre and workload optimisation.
• Customer Growth: The number of deals with 8 or more modules grew 95% Y/Y and the number of subscription customers with 5, 6 and 7 or more modules reached 65%, 44% and 28%, respectively.

New Growth Drivers:

• Data Protection: With the recent launch of Falcon data protection, CrowdStrike has already secured hundreds of customers, including several Fortune 1000 companies, positioning itself in a new multibillion-dollar market.
• Falcon for IT: This new offering helps customers with enterprise search, patching, deployment and device health, accumulating an 8-figure pipeline shortly after launch.
• Charlotte AI: Aimed at making cybersecurity more conversational and productive, Charlotte AI has achieved close rates of nearly 90% in early trials.

Guidance and Outlook:

• Next Quarter: Management expects revenue between $958.3 million and $961.2 million, representing 31% Y/Y growth and EPS between $0.98 and $0.99, 9% ahead of consensus expectations.
• Fiscal Year 2025: Revenue is forecasted to range from $3.98 billion to $4.01 billion, growing 30% to 31% Y/Y. Operating income is projected to be between $890.1 million and $916.5 million, with EPS expected between $3.93 and $4.03.
• Free Cash Flow: The free cash flow margin guidance is maintained at 31% to 33% of revenues.

Overall: CrowdStrike’s ability to sustain strong demand, drive platform consolidation and expand into new growth areas highlights its resilience and strategic positioning. Despite the challenging macro environment, the company’s robust pipeline, strategic partnerships and continuous innovation support its trajectory toward achieving $10 billion ARR and solidifying its market leadership.

Source: CrowdStrike 2024

Zscaler: Tenacious ‘C’ for Cybersecurity⁸

Zscaler continues to demonstrate robust performance and resilience in a challenging market environment. With a focus on Zero Trust security and innovative cloud-based solutions, the company has exceeded expectations in multiple key metrics for the third quarter of fiscal year 2024.

Key metrics in Q3 Fiscal Year 2024:

• Revenue grew 32% Y/Y to $553 million, up 5% sequentially and surpassing guidance.
• Operating margin reached a record 22%, a significant increase from 17% in the prior year.
• Adjusted EPS was $0.69 to $0.70, assuming 165 million fully diluted shares.

Noteworthy items:

• ARR: The number of customers with over $1 million in ARR increased 31% Y/Y to 523. Customers with over $5 million in ARR exceeded 50.
• Gross Margin reached a record high of 81.4%, up from 80.2% in the year-ago quarter, benefiting from optimised data centre operations and a consistent pricing environment.
• Customer Growth: Zscaler continues to see strong adoption of its Zero Trust Exchange platform, with significant wins in financial services, manufacturing and federal sectors.

Guidance and Outlook:

• Next Quarter Q4 Fiscal Year 2024: Revenue is expected to be between $565 million and $567 million, reflecting 24% to 25% Y/Y growth and EPS is projected to be between $0.69 and $0.70.
• Fiscal Year 2024: Revenue is forecasted to range from $2.140 billion to $2.142 billion, growing approximately 32% Y/Y. Calculated billings are expected to be between $2.603 billion and $2.606 billion, reflecting 28% Y/Y growth.
• Free Cash Flow: The free cash flow margin is expected to remain in the low-to-mid 20% range.

Overall: Zscaler’s strong performance in Q3 Fiscal Year 2024 highlights its resilience and strategic positioning in the cybersecurity market. The company’s innovative Zero Trust Exchange platform, continued expansion into new market segments and strategic acquisitions are driving growth and customer adoption. With a focus on delivering superior security and cost savings through its platform, Zscaler is well-positioned to capitalise on the growing demand for Zero Trust security solutions and achieve its long-term growth objectives.

Source: Zscaler 2024

Conclusion

The cybersecurity sector remains a critical area for investment, especially as cyber threats continue to evolve and become more sophisticated. The latest earnings from industry leaders like Palo Alto Networks, CrowdStrike and Zscaler underscore the robust demand for advanced cybersecurity solutions. Despite recent pullbacks in stock prices, the sector’s fundamentals are strong, driven by ongoing digital transformation and increasing regulatory requirements.

Looking ahead, the integration of AI in cybersecurity will be a game-changer, enhancing threat detection and response capabilities. Additionally, the focus on Zero Trust and continuous threat exposure management will further solidify the sector’s disruptive prospects. For investors, the current market conditions present a unique opportunity to buy into high-quality cybersecurity stocks at attractive valuations.

Please see Part 2 of our Mid-Year Cybersecurity Review for a deeper dive into these trends and our detailed investment perspectives.