Cybersecurity has been a secular growth trend for a long time, but the rapid shift to cloud computing over the past few years has focused attention on how far behind many organizations are in securing their operations.
In the current race to combat cybercrime, one company has emerged as a clear and often overlooked winner. microsoft (MSFT 1.99%)The company’s security business exceeded $20 billion in calendar year 2022, up from $15 billion in 2021 and $10 billion in 2020. At the same time, however, the much larger consumer PC and software businesses are struggling to cut consumer spending.
So if you’re looking for pure play in the rapidly growing cybersecurity field, Palo Alto Networks (PANW 0.68%) When Fortinet (FTNT 1.43%) Watch now.
Palo Alto Networks: Investing in Next-Generation Security
Despite strong growth across the industry, cybersecurity is a tricky business. Bad actors are constantly adapting and evolving their attacks, requiring constant innovation to remain competitive and relevant. To harden its platform, Microsoft has spent billions of dollars in research and development over the years and acquired a number of small security companies.
However, the company is not the only company to make such a large investment to expand its business. Palo Alto Networks, the leading pure play in cybersecurity, is also fairly well-funded. The company has acquired nearly a dozen next-generation security startups from 2018 to 2021, and recently completed a short acquisition hiatus, ending Cider Security for $195 million in cash. I bought it.
As of this writing, Palo Alto has a market cap of $48 billion and $3.8 billion in cash and short-term investments. Also, last year he generated over $2.4 billion in free cash flow (FCF).
Palo Alto believes it can average double-digit revenue growth over the next few years as a result of its research and acquisition spending. FCF generation will also remain high, allowing us to make more acquisitions and buy back shares if necessary.
Next-Generation Services (NGS) is fast approaching half of total revenue, making the company one of the more innovative leading cybersecurity companies.
Microsoft’s recent earnings show an overall slowdown in cloud spending growth, which isn’t good news. With the global economy cooling in his 2023, many organizations are slow to move operations to the cloud as they try to keep costs down. A cloud slowdown could also impact Palo Alto’s near-term financial results.
Despite this, even in trying times, the cloud industry is still growing at over 20% year-over-year. Palo Alto Networks should have plenty of opportunities to drive leading cybersecurity platforms in the years to come. The company’s stock is trading at 20 times his FCF on his 12-month footing, better than his 31 times FCF in the slow-moving Microsoft empire.
Fortinet: Unique Ways to Distribute Security Software
The main advantage that Microsoft has over its competitors in cybersecurity software (and all software products) is its unrivaled distribution. Windows is still the operating system for billions of PCs and laptops around the world, and Office 365 has pretty much become the default for work and personal productivity.
Such a large user base makes it easy for Microsoft to cheaply cross-promote other services (such as its vast cybersecurity portfolio) to existing users.
Fortinet doesn’t have billions of devices running operating systems that deliver services, but it does have a lot of security hardware installed. A next-generation firewall called FortiGate that monitors data traffic. Its products can be found everywhere, including Internet and mobile network infrastructure, data centers running public cloud services, and corporate private networks.
Once the hardware is installed, Fortinet will receive a steady stream of software and services revenue from the device. And in recent years, the company has developed other cloud-based security software that it can market to its existing enterprise customer base.
This is a differentiated and highly successful business model. The company has achieved double-digit revenue growth for years and remains highly profitable under generally accepted accounting principles (GAAP) and his FCF. Fortinet has a market capitalization of $41 billion and aggregate cash and short-term investments of over $1.7 billion. In the last 12 months he generated his FCF of $1.2 billion.
At this point, the stock will trade at a premium. The stock is valued at 58x past 12-month earnings (or 31x on a one-year projected earnings basis) and 37x his FCF for the past 12 months. Fortinet is expected to start turning a profit after several years of rapid hardware adoption.
Microsoft is indeed a “cheap” stock with 27x earnings per share and 31x FCF. Despite this, Fortinet is still growing, profitability is improving, and the demand for cloud and other advanced network security isn’t going away any time soon. This pure-play cybersecurity business still looks like a buy in 2023 and beyond.
Nicholas Rossolillo and his clients have held positions at Fortinet, Microsoft, and Palo Alto Networks. The Motley Fool has positions in and recommends Fortinet, Microsoft and Palo Alto Networks. The Motley Fool’s U.S. headquarters has a disclosure policy.