Palo Alto Pops on Earnings, Expanse Deal Detailed

Palo Alto Networks (PANW) today released its first fiscal 2021 quarterly earnings, adding momentum to the enthusiasm of last week's announcement that it will acquire enterprise security startup Expanse Inc. for an estimated $800 million. The earnings and the deal highlight the ongoing morphing of traditional firewalls into smarter solutions better adapted to cloud networks.

Quarterly revenues grew 23% year-over-year to $946 million. Non-GAAP net income rose 50% year-over-year to $158.1 million, or $1.62 per diluted share. Management is guiding investors to expect 19% to 21% growth in revenues next quarter.

Palo Alto shares rose on the news, trading this morning at $269.41, up $10.71 (4.14%).

Palo Alto: Expansive on Expanse

Palo Alto's good news was followed up with the boast of having scored Expanse, the latest in a series of acquisitions aimed at bolstering the company’s cybersecurity presence in an increasingly competitive market. Over the last year or so, Palo Alto's security acquisitions have included the The Crypsis Group ($625 million); CloudGenix ($425 million); Aporeto ($150 million); and Zingbox ($75 million).

Each of these deals has been aimed at augmenting Palo Alto’s products to exceed the role of firewall. Like rivals Juniper (JNPR) and Fortinet (FTNT), Palo Alto is focused on making security intrinsic to digitally transformed networks, instead of a separate operational function.

At first, this approach suffered a bit when Palo Alto execs instructed salespeople to focus on Cortex and the company’s other next-generation security offerings instead of on firewalls. The fallout came in disappointing figures for Palo Alto’s pre-Covid earnings report in February.

Since then, however, Palo Alto has reversed the setback, and investors seem pleased with the new acquisition. “Today’s acquisition of EXPANSE is a nice augmentation to the overall PANW portfolio,” wrote Sterling Auty and colleagues at J.P. Morgan equity research in a note last week. “The pandemic and changing work arrangements are causing companies to make many changes to IT architectures and that raises the risk of exposing IT assets, and this acquisition is perfectly suited to help customers find those vulnerabilities.”

Expanse: Advanced Threat Protection

Expanse, founded in 2012 and based in San Francisco with roughly 200 employees, tracks all of an enterprise’s Internet-connected assets, known or unknown to IT. Once found, the software identifies any suspicious patterns of communication from threatening sources and mitigates those threats. The point is to give IT information about the network (cloud- or premises-based, or both) from the viewpoint of a potential attacker seeking weak points of entry.

In a press release last year, Matt Kraning, Expanse CTO and co-founder, said the startup’s solutions are meant to “fill in gaps between existing solutions that are only focused inside the firewall, and [meet] the need to address the increasing number of bad actors who look for ways to break into networks from outside the firewall.”

That outside-in view is what Palo Alto hopes to add to its Cortex line of artificial intelligence-assisted cybersecurity products, which feature analytics and orchestration. “By integrating Expanse's attack surface management capabilities into Cortex after closing [within the next six months], we will be able to offer the first solution that combines the outside view of an organization's attack surface with an inside view to proactively address all security threats,” said Palo Alto CEO Nikesh Arora in a prepared statement.

DARPA Roots

Expanse’s co-founders, CEO Tim Junio and CTO Kraning, who will both join Palo Alto post closing, are Ph.D.s with expertise in a range of cybersecurity areas, including what they term large-scale distributed sensing. Both also have ties to U.S. government tech security projects, having worked at the U.S. Defense Advanced Research Projects Agency (DARPA), and they credit that experience for inspiring the technology underlying Expanse’s solutions, particularly its flagship, Expander.

Since its release in 2016, that product has been adopted by a range of large customers, including CVS Health, Accenture, PayPal, Lockheed Martin, and, perhaps not surprisingly, the U.S. Departments of Defense and Energy and all branches of the U.S. military.

By the end of October 2020, Expanse claimed to have seen 100% year-over-year revenue growth, and it was ready for its next move. Perhaps the Palo Alto merger was suggested by one of Expanse’s many investors, who have contributed about $136 million in three rounds of funding, according to Crunchbase.

Those investors include some interesting individuals. While the last Series C round of $70 million was led by TPG Growth, contributors also included Arianna Huffington, Peter Thiel, Egon Durban (ex-Silver Lake Partners CEO), Taylor Glover (CEO, Turner Enterprises), and Sam Palmisano (ex-IBM CEO), along with existing investors NEA, IVP, Founders Fund, and MSD Capital.

A Look Ahead: Raised Guidance

All of this bodes well for Palo Alto Networks, but nothing is guaranteed in today's volatile markets. With management raising guidance to revenue growth of 19% to 21% for the next quarter, it's clear that Palo Alto is taking advantage of the trend toward large investment in security technology.

Of course, the effort of swallowing the $800 million acquisition will challenge the company even in its current success. This is evident in this quarter's GAAP net loss figure -- $92.2 million, or $0.97 per diluted share, up nearly 55% year-over-year.

Still, signs are promising, and demand is rising for the kinds of products Palo Alto is focused on delivering. Solid changes should be evident next quarter.