The surge in hacks and data breaches worldwide has made the cybersecurity industry a hot one for growth investors. Research firm Markets and Markets sees the cybersecurity market growing from $122.5 billion in 2016 to $202.4 billion by 2021, and the Purefunds ISE Cyber Security ETF -- which owns a basket of top cybersecurity stocks -- rallied more than 30% over the past 12 months.
One frequently cited stock in that industry is Palo Alto Networks (NYSE: PANW), the next-gen firewall vendor that went public five years ago and more than tripled in value. However, growth investors often overlook one of Palo Alto's more compelling peers, CyberArk Software (NASDAQ: CYBR), which leads the market in privileged account management (PAM) solutions. Here are three simple reasons that CyberArk is a better growth play than Palo Alto.
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1. CyberArk dominates a niche, Palo Alto doesn't
Cybersecurity companies often struggle to grow their moats wide enough to counter bigger tech companies, which bundle similar services into their own security platforms. This arguably makes niche players safer than companies stuck in the crosshairs of Cisco (NASDAQ: CSCO) or Microsoft (NASDAQ: MSFT).
Palo Alto is being targeted by both tech giants. Cisco offers a wide range of next-gen firewalls, which the company claims can detect threats within six hours -- versus the industry average of 100 hours. Cisco is constantly using acquisitions to beef up its cybersecurity business, its fastest growing unit, which generated $1.6 billion in revenues during the first nine months of 2017. That growth threatens Palo Alto, because Cisco bundles its security products with its market-leading networking hardware.
Earlier this year, Microsoft announced that it would invest over $1 billion annually on cybersecurity R&D. Its new Windows Defender ATP (Advanced Threat Protection) system for Windows 10, for example, is powered by Microsoft's cloud-based security graph -- which gathers data from over a billion Windows devices worldwide. As that system grows, it could reduce the need for third-party solutions like Palo Alto's firewalls.
Meanwhile, CyberArk leads the market in PAM solutions, which protect privileged accounts from internal threats like disgruntled employees or corporate spies. This represents a much smaller market than next-gen firewalls, but CyberArk doesn't face much competition in this niche -- which RnR Market Research thinks will grow at a CAGR of nearly 20% between 2016 and 2020. That dominance is reflected in CyberArk's PAM partnerships with tech giants like Hewlett-Packard Enterprise and IBM -- which indicate that it's probably smarter to work with CyberArk than compete against it.
2. CyberArk isn't crippled by SBC expenses
Palo Alto is based in Silicon Valley, a job market that is known for extravagant salaries and stock bonuses. Last quarter, Palo Alto's stock-based compensation (SBC) expenses rose 7% annually to $120.6 million, which gobbled up a whopping 28% of its revenue.
CyberArk is based in Petah Tikva, Israel. Cybersecurity is a huge growth industry in Israel, since many members of the IDF's cybersecurity unit join cybersecurity companies. But it's also a market which doesn't demand massive stock bonuses. That's why CyberArk spent just $5.2 million, or 9% of its revenues, on SBC expenses last quarter.
3. CyberArk is profitable, Palo Alto isn't
Palo Alto's liberal use of stock bonuses has kept it unprofitable on a GAAP basis. The company emphasizes the growth of its non-GAAP profits, which exclude that big expense, but the company can't be considered "truly" profitable. Last quarter, Palo Alto's non-GAAP net income rose 35% annually to $57.1 million, but its GAAP net loss only narrowed slightly from $64.1 million to $60.9 million.
Meanwhile, CyberArk's more conservative use of stock bonuses enables it to post consistent profits by both non-GAAP and GAAP measures. Its non-GAAP net income rose 23% to $10.2 million last quarter, and its GAAP net income rose 74% to $7.5 million.
Looking ahead, Wall Street sees Palo Alto's revenue and non-GAAP earnings respectively rising 26% and 55% this year. CyberArk's revenue is expected to grow 25% this year, but its non-GAAP earnings are expected to dip 4% due to its recent acquisition of DevOps security company Conjur and higher expenses related to R&D and the expansion of its sales team. Nonetheless, CyberArk will likely remain profitable on a GAAP basis.
The key takeaways
Palo Alto isn't a bad growth stock, but if you're looking for just one high-growth cybersecurity play, CyberArk is a much better buy. CyberArk's defensible niche, responsible use of stock bonuses, and rock-solid profitability should make it a safer growth play than Palo Alto for the foreseeable future.
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Teresa Kersten is an employee of LinkedIn and is a member of The Motley Fool's board of directors. LinkedIn is owned by Microsoft. Leo Sun owns shares of Cisco Systems. The Motley Fool recommends Cisco Systems, CyberArk Software, and Palo Alto Networks. The Motley Fool has a disclosure policy.