Palo Alto Networks Probes New Equity Structure For Cloud, AI Unit

February 22, 2021, 07:00 PM EST

‘[The market] values the network security business in cash flow and values the cloud and AI business in ARR. So we want to be able to create the opportunity for the market to value our businesses differently,’ says CEO Nikesh Arora.

Palo Alto Networks is exploring different equity structures for its cloud and AI security business that could potentially allow different investors to bankroll the high-growth practice.

The Santa Clara, Calif.-based platform security vendor said its board of directors has approved creating a vehicle for its employees to invest in equity around the company’s cloud and AI business, more tightly aligning the interest of employees and shareholders, said CEO Nikesh Arora (pictured). The cloud and AI business includes the company’s Prisma Cloud, Cortex security operations, and incident response services.

“[The market] values the network security business in cash flow and values the cloud and AI business in ARR [annual recurring revenue],” Arora told investors Monday during the company’s earnings call. “So we want to be able to create the opportunity for the market to value our businesses differently to create more transparency for the shareholders.”

Palo Alto Networks’ cloud and AI business has $735 million of annual recurring revenue and is growing at 77 percent of a year-over-year basis but has negative cash flows, according to Arora. Conversely, he said the company’s network security unit – which includes its firewalls, SASE and security subscription offerings – has $1.5 billion of free cash flow and margins increasing from 38 percent to 41 percent.

“The market looks at them [network security and cloud/AI security] together and values us one certain way,” Arora said. “Maybe the market will value us differently if we look at it differently. So we‘re just exploring the opportunity of being able to make that value more transparent.”

Palo Alto Networks has a valuation of $37.23 billion, which makes it the second most valuable pure-play cybersecurity vendor in the world. But the company is still worth nearly $13 billion less than CrowdStrike despite having more than quadruple the revenue. Arora told investors Palo Alto Networks’ cloud and AI business competes with CrowdStrike, specifically around XDR (extended detection and response).

“We are looking at various equity structures that allow us to create incentive plans, as well as potentially in the future monetize the ClaiSec [cloud and AI security] business for a different set of investors compared to the overall Palo Alto business,” Arora said. “[This] also allows us to keep investing in the cloud and AI business in the interest of driving more ARR.”

Arora told investors that he isn’t looking to change Palo Alto Networks’ operating structure. Specifically, he said Palo Alto Networks will still be run as a single company with two agile business units. The firm also brought in IBM X-Force VP Wendi Whitmore to run Palo Alto Networks incident response services, a newly-formed team that combines Unit 42 and The Crypsis Group and is part of the cloud and AI unit.

Palo Alto Networks sales for the quarter ended Jan. 31 jumped to $1.02 billion, up 24.5 percent from $816.7 million a year ago. That beat Seeking Alpha’s estimate of $968 million.

The company recorded a net loss of $142.3 million, or $1.48 per diluted share, 93.1 percent worse than a net loss of $73.7 million, or $0.75 per diluted share, the year before. On a non-GAAP basis, net income soared to $154.2 million, or $1.55 per diluted share, up 28.2 percent from $120.3 million, or $1.19 per diluted share, last year. That beat Seeking Alpha’s net income projection of $1.43 per diluted share.

Palo Alto Networks’ stock sunk $18.35 (4.77 percent) to $366 per share in after-hours trading Monday. That’s the lowest the company’s stock has traded since Feb. 1.

Subscription and support revenue for the quarter leapfrogged to $762.2 million, up 33.7 percent from $570.2 million last year. Product revenue for the quarter inched ahead to $254.7 million, up 3.3 percent from $246.5 million the year prior.

For the coming quarter, Palo Alto Networks expects diluted non-GAAP net income of $1.27 to $1.29 per share on total sales of $1.05 billion to $1.06 billion. Analysts had been expecting non-GAAP earnings of $1.29 per share on total revenue of $1.05 billion, according to Seeking Alpha.