【the ledge amphitheater parkway dr waite park mn】Why Palo Alto Networks Has Spent Over $1 Billion on Acquisitions
Over the last two years,the ledge amphitheater parkway dr waite park mn
Palo Alto Networks
(NYSE: PANW)
has been on a tear. Not only has the stock nearly doubled in value over the last 24 months, but the company has also been on an acquisition spree. The cybersecurity outfit made its largest yet just ahead of its 2019 fiscal year second quarter, fast-tracking its move into artificial intelligence capabilities as customers deal with increasingly complex cyber threats from the bad guys.
The price tag
Palo Alto Networks recently announced its intent to purchase privately held Demisto, based in Cupertino, California. Total consideration is $560 million payable in cash and stock, an impressive sum given that the smaller security company was founded less than four years ago in 2015.
That's the fifth buy of a smaller peer Palo Alto has made since the beginning of 2017. The total price tag is over $1 billion, a big chunk of change considering Palo Alto's current enterprise value is $21 billion. It's been money well spent, though, helping the company expand beyond its legacy of providing firewalls (a system designed to prevent unauthorized access to a network). A few years ago, booming growth in cloud computing necessitated the expansion in that direction. The result was a 29% and 47% increase in revenue and adjusted earnings during the
2018 fiscal year
, and revenue and adjusted earnings so far in 2019 are up another 31% and 48%.
Company
Acquisition Amount
Company Description
Demisto
$560 million
Security orchestration, automation, and response services
RedLock
$173 million
Cloud computing security services
Secdo
Unconfirmed for $100 million
Israel-based data collection and visualization for endpoint attack detection and response
Evident.io
$300 million
Cloud computing security services
LightCyber
$105 million
Automated machine learning behavioral analytics technology
Data source: Palo Alto Networks.
What Palo Alto Networks got for its money
Though Palo Alto has been shelling out big sums for smaller rivals, cybersecurity is a fast-evolving industry. Demisto will be an especially ambitious purchase, but CEO Nikesh Arora said the small firm is expected to post at least $50 million in sales this year. That's huge growth for a four-year-old endeavor.
An artist's illustration of AI: a human silhouette filled in with computer data.
Image source: Getty Images.
And that's exactly why Palo Alto was willing to pony up. Demisto is a specialist in security orchestration, automation, and response (SOAR) services, an emerging segment in the cybersecurity industry. Big data company
Splunk
(NASDAQ: SPLK)
also made several buyouts last year in the same area. Automated responses to digital threats powered by machine learning (a type of artificial intelligence) is an increasingly important need for organizations as they navigate the digital age, and Palo Alto wants to accelerate its strategy in AI and automation.
Story continues
It's yet another evolution in the digital space as companies around the globe slowly migrate away from legacy operations. Over the last two years, Palo Alto has transformed itself into a diverse provider of security services to protect that transformation. First was a focus on
securing cloud-based operations
, and now Demisto helps the company's customers learn from its data and automatically respond to anomalies. In response to the ever-shifting landscape, management said during its second-quarter earnings call that more acquisitions could be forthcoming. It's a good move to capture market share as the industry responds to nefarious activity and changing needs from its customers -- one that Palo Alto can afford, as it has over $2.8 billion in cash and short-term investments on the books.
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Nicholas Rossolillo
owns shares of Splunk. The Motley Fool owns shares of and recommends Palo Alto Networks and Splunk. The Motley Fool has a
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- 5%, led by a 17% increase in average ticket and a slight decline in traffic. Growth in the quarter reflected the impact of households stocking up on essentials like paper goods and cleaning supplies as the pandemic became a nationwide concern, along with strength in discretionary categories as the quarter came to a close and stimulus dollars and tax refunds were disbursed.
As shown below, the results in the quarter materially changed the trend in two-year stacked comps for each of the banners, along with a significant acceleration for consolidated comps.
The increase in consolidated comps was the primary driver of an 8% increase in revenues to $6.3 billion. The company ended the quarter with 15,370 locations, up less than 1% year-over-year. This reflects a 7% increase in Dollar Tree units, offset by a 4% decline in Family Dollar units.
The top-line results at each banner flowed through to their respective income statements, with Dollar Tree gross margins and operating margins declining year-over-year while Family Dollar gross margins and operating margins expanded year-over-year. On a consolidated basis, gross margins contracted by 120 basis points in the quarter to 28.5%, reflective of a shift to lower-margin consumables, tariff costs and the impact of markdowns from the Easter headwinds at the Dollar Tree banner. The company saw slight operating leverage on SG&A from higher comps, with the net result being an 80 basis point contraction in operating margins to 5.8%, with operating income declining 5% to $366 million. This is not adjusted for $73 million of pandemic-related costs, such as PPE supplies.
In the first quarter, the company opened 85 stores (net of closures) and completed 220 Family Dollar renovations to the H2 format. Importantly, comps at renovated Family Dollar stores continue to outpace the chain average by more than 10%. On the call, management indicated that they plan on reducing both the number of new store openings (from 550 to 500) and the number of H2 renovations (from 1,250 to 750) in 2020.
Personally, given the fact that Family Dollar is seeing material benefits to its business from the pandemic with new or lapsed customers coming into its stores, I think the company should try to get more aggressive with its renovation plans, not less. On the other hand, you could argue that renovations cause short-term disruptions and limit their ability to fully capitalize on the business momentum they are currently experiencing.
As a result of fewer new stores and remodels, management now expects 2020 capital expenditures to total $1.0 billion compared to previous guidance of $1.2 billion. In addition, the company has temporarily suspended share repurchases. At quarter's end, the company had $1.8 billion in cash on its balance sheet compared to $4.3 billion in total debt.
Conclusion
In recent years, Dollar Tree has been a tale of two cities. While its namesake banner has generally delivered impressive financial results, Family Dollar has been a persistent underperformer. This quarter, those results flipped, and given what we've seen in the weeks since quarter's end, there's a decent possibility that we will see something similar in the coming months. As the CEO noted, the second quarter is off to a very good start at Family Dollar.
Here's the important question: how useful is that information is in terms of making future predictions about the business? Will recent success at Family Dollar translate into long-term success for the banner? The optimistic take is that new or lapsed customers, especially those visiting the renovated stores, could become recurring business for the banner. The pessimistic take is that they have experienced short-term success out of necessity as people went to any store that was open to try and find essentials like toilet paper and hand sanitizer that were largely out of stock throughout the retail landscape. From that view, many of these customers could abandon the retailer when life returns to normal. As Philbin noted on the conference call, early on [during the pandemic], folks needed us. Will people still shop as much at Family Dollar when it's no longer a necessity?
Personally, I do not place too much weight on the recent results. I will need to see incremental data points that indicate that Family Dollar has truly won sustained business from these new customers. While I still believe that the Dollar Tree banner is a well-positioned retailer with attractive unit returns, I'm not yet willing to say the same thing for Family Dollar. For that reason, along with the recent run-up in the stock price, I plan on staying on the sidelines for now.
Disclosure: None
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