Why I'm Buying More CyberArk but Avoiding Palo Alto Networks

By Markets Fool.com

I recently bought more shares of CyberArk after the cybersecurity company posted solid sales and earnings growth on May 5. I previously started my position in CyberArk before that earnings release, and I discussed my four main reasons for doing so: its "best in breed" reputation in privileged accounts protection, solid fundamentals, new partnerships, and buyout potential.

Continue Reading Below

However, shares of CyberArk were recently dented by mixed earnings from industry peer Palo Alto Networks , which provides next-generation firewall protection for businesses.

Palo Alto's 48% annual revenue growth, 61% billings growth, and 88% non-GAAP net income growth all looked impressive compared to previous quarters, but the stock fell 12% on May 27 because of soft guidance and its widening GAAP loss. Some analysts, like Wunderlich's Rob Breza, recommend buying Palo Alto after that big dip, but I believe the stock remains a less compelling buy than CyberArk for three simple reasons.

1. A higher valuation

Palo Alto's enterprise value to sales ratio of 9 remainsmuch higher than comparable companies like CyberArk and FireEye , which have respective ratios of 6 and 4. Palo Alto bulls might argue that the stock deserves a higher multiple because of its stronger sales growth -- the company is expected to post47% sales growth this year, compared to 31% for CyberArk and 28% for FireEye.

However, Palo Alto's high valuation, along with its enterprise value of nearly $11 billion (which could require a $15 billion-plus buyout), arguably makes it a less attractive takeover target than either CyberArk or FireEye, which respectively have enterprise values of $1 billion and $2.4 billion.

Continue Reading Below

2. A lack of profitability

Moreover, CyberArk beats Palo Alto in terms of GAAP profitability. CyberArk's GAAP net income improved 2% annually to $4.3 million last quarter. That's not terribly impressive, but it gives CyberArk an actual P/E ratio (albeit a high one at around 60), which makes the stock easier to properly value. That profit is also much better than Palo Alto's GAAP net loss, which widened from $45.9 million to $70.2 million between the third quarters of 2015 and 2016.

A big weight on Palo Alto's bottom line was stock-based compensation, which surged 76% to $112.7 million (33% of its revenue) last quarter. CyberArk spent around 31% of its revenue on stock-based compensation last quarter, but it has generally maintained tighter control over its other operating expenses than Palo Alto.

3. More direct competitors

CyberArk faces less competition than Palo Alto, because it's widely considered the market leader in the niche market of privileged account management (PAM). CyberArk secures the accounts of 40% of the Fortune 100 companies and 17 of the 20 biggest banks in the world, which prevents hackers and disgruntled employees from stealing data. Its onlymeaningful competitor in that space is CA Technologies , but research company IDC notes that CyberArk remains the "big gorilla" of the PAM market.

Palo Alto faces much stiffer competition in the next-generation firewall market. Check Point Software , which previously expressed interest in buying CyberArk, offers a firewall thatcompetes against Palo Alto's. Networking giant Cisco purchased cybersecurity companies Sourcefire and ThreatGRID to improve its next-generation firewall and threat prevention solutions. If Cisco's firewall options continue improving, and it aggressively bundles those services with its networking hardware, Palo Alto could lose market share and be forced to cut prices.

CyberArk doesn't have to worry about any comparable threats for now. Moreover, CyberArk's recent certificationfrom the U.S. Department of Defense will ensure it remains the "best in breed" player in the PAM market for the foreseeable future. Its C3 Alliance, which aligns its PAM interests with Intel, FireEye, Symantec, and other major tech companies, will also widen its moat against potential rivals like CA.

The key takeaways

CyberArk and Palo Alto are both risky plays, but more reasonable valuations, better profitability, and less competition make the former is a more compelling investment than the latter. I'm keeping an eye on Palo Alto and will revisit the stock if it declines further, but I wouldn't consider its recent plunge to be a great buying opportunity.

The article Why I'm Buying More CyberArk but Avoiding Palo Alto Networks originally appeared on Fool.com.

Leo Sun owns shares of CyberArk Software. The Motley Fool owns shares of and recommends Check Point Software Technologies and FireEye. The Motley Fool recommends Cisco Systems, CyberArk Software, Intel, and Palo Alto Networks. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.