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Crack Into These Cybersecurity Firms

Palo Alto Networks' moat trend is improving, while Check Point Software trades at a discount.

Billy Fitzsimmons: We recently re-evaluated our entire cybersecurity coverage list. And in doing so, we took a fresh look at Palo Alto Networks. We still maintained the no-moat rating, but we upgraded the trend to positive from stable. Overall, we think there's two major trends affecting cybersecurity vendors like Palo Alto Networks. First, complexity and second, consolidation.

It used to be that network security vendors were creating firewall services whether physical or virtual. Today, the vectors of attack for enterprises is becoming much more complex. You have firewall, you have SaaS, you have endpoint security, cloud security. They are making the enterprise security efforts much more byzantine. You need multiple solutions to protect yourself from all those vectors.

Second is consolidation. It used to be that a point vendor would sell you the services for endpoint which would be separate from firewall. Now we're seeing consolidation where one vendor like Palo Alto can do all those things together. We think that's increasing the switching costs for a company like Palo Alto Networks. We have solid uptick in new products such as WildFire, sandboxing operation, and we are also seeing growth in nascent products such as VM-Series and Aperture, which are poised to grow.

We think overall instead of just selling the next-generation firewall, which is Palo Alto's bread and butter, customers are going to increasingly buy subscription offerings from them, which is going to keep growing average revenue per user, which has been ticking upward the past five years. We think this is poised to continue and as enterprises purchase more and more solutions from Palo Alto Networks, it engrains Palo Alto's services inside the IT infrastructure of its client base, growing switching costs.

Now, having said that, our $182 fair value estimate places Palo Alto Networks in fairly valued territory. For investors looking to get into this space, we'd recommend a look at Check Point Software Technologies, which we believe is trading at a discount. It's poised to grow at a slower rate than Palo Alto, but we like the firm's 50% operating margins, $4 billion in cash and marketable securities, and strong management team that we think is poised to continue to buying back shares over the ensuing years.

William Fitzsimmons does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.