The cybersecurity market is valued at $173.5 billion in 2022. This is expected to grow at a steady average annual growth rate of 8.9%, reaching $266.2 billion by 2027, according to research by Markets and Markets. Zscaler Co., Ltd. (ZSAccording to Gartner, Financial is poised to benefit from this trend as a leader in security services edge. The company continues to deliver strong financial results, reporting the highest growth in both sales and profits in the third quarter of 2023. This analysis details the company’s business model, financial position, and valuation. Let’s dive in.
innovative business model
Zscaler has pioneered so-called “zero trust” networking practices. In a typical information technology network, when users log into a computer or system, they are “trusted” by default to access all applications and tools. The danger of this is that hackers can gain access to your system through low-risk applications before moving laterally to high-risk applications such as finance. Zero Trust techniques solve this problem through a concept called least privilege access. This means users only have access to the applications they need. For example, an employee in the human resources department is given access to her HR application. While the financial officer is granting access to the financial application. This is even more important for outside contractors who perform menial tasks within your organization but have access to company-wide data.
How Zscaler solves this problem is through security policies and zero trust exchanges. It acts as an “intelligence switchboard” over a private network to keep your data safe through encryption. Many organizations are now using virtual private networks to solve this challenge. However, many of these can be time-consuming and do not actually stop the lateral movements hackers make.
The company’s products are sold in bundles, providing significant upsell opportunities to existing customers. The company’s products include Secure Internet Access (ZIA), Secure Private Access (ZPA), Digital Experience (ZDX), and Posture Control.
AI improvements
Zscaler has introduced a number of artificial intelligence tools and features to enhance its existing platform. This includes using AI to improve threat detection and response by providing AI models with access to vast amounts of threat signature data. The company also introduced data loss prevention for generative AI queries and output, which is essential for audits. The whole point of this is also to keep users’ data private and confidential, which has been a concern for many organizations whose employees use his ChatGPT.
The company’s AITotal platform includes a risk scoring system that automatically assesses the risk of various AI applications, and AI access controls monitor in-app usage and control Allows fine-grained access.
Zscaler also launched a security autopilot solution that helps AI models automatically perform analysis and recommend policies.
Additionally, Zscaler Navigator includes a natural language interface that allows users to interact with the product.
growing finance
Zscaler reported strong financial results for the third quarter of 2023. Revenue of $418.8 million exceeded analyst expectations by $7.24 million and increased 46% year-over-year.
Billings increased 40% year over year to $482 million, and remaining performance obligations increased 36% year over year to $3 billion. This bodes well for future earnings stability.
Dollar retention was an impressive 125%, driven by increased upsells.
In one upsell opportunity, a bank in Asia Pacific upgraded 150,000 users to Zscaler. This reduced the latency to open new branches by 50% and eliminated the need for firewalls and other external network services. Financial services is a strong recruiting area for Zscaler, with the company serving eight of his 10 largest financial services companies in the world.
Zscaler currently has 400 customers with an impressive annual recurring revenue of over $1 million. This includes his 35 clients, each of whom has an ARR of over $5 million. Such high ticket prices demonstrate the value of the platform and its selective sales process.
The company takes a consultative sales approach to organizations in becoming their strategic partner. The company created a “CFO-ready” business case that demonstrated the solution’s return on investment and payback period. This high-touch method is essential, especially given the current climate where transactions are under greater scrutiny.
Profit margin and balance sheet
Turning to profitability, Zscaler operates with a strong gross margin of 80.2%, down slightly from 80.6% a year ago due to increased public cloud usage, but overall It remains strong.
The company reported operating expenses increased 33% to $272 million. While this is a worrying sign for most companies, approximately $30 million of this increase is due to increased research and development costs. Additionally, higher compensation costs also contributed significantly, but I don’t think that’s all bad as Zscaler strives to retain the best talent.
Despite higher expenses, operating margin increased 600 basis points year over year to 15.3%. Free cash flow margin was 18%.
ZS data creator guru focus
Data center capital expenditures are expected to be a low single-digit percentage of full-year revenue.
Zscaler has a strong balance sheet with $1.97 billion in cash, cash equivalents, and short-term investments. Total debt is $1.2 billion, which seems manageable given that most of it is long-term.
evaluation
Zscaler’s price-to-sales ratio is 14.32, which is lower than its average over the past five years.
Based on historical ratios, past financial performance and analyst estimates of future earnings, GF Value Line has a fair value of $422 per share. Therefore, the stock is significantly undervalued as of this writing.
guru’s interest
master investor
Ron Baron (Trading, Portfolio),
joel greenblatt (Trading, Portfolio) and
Stephen Cohen (Trades, Portfolios) All were buying stocks in Q2 2023. The stock traded at an average price of $122 per share during the quarter, which is slightly cheaper than the stock was trading at at the time of writing.
final thoughts
Zscaler is a great company poised to benefit from the growth of the cybersecurity industry. While the AI market offers many great opportunities, it also increases risks for organizations. Therefore, we believe this will be a net benefit to Zscaler’s security business. The company continues to deliver strong financial results. So this looks like it could potentially be a great long-term investment.