Name That Trade – $PANW: White Hat In Hand

by Dan January 13, 2015 12:11 pm • Commentary

My Friend and CNBC Fast Money stalwart Guy Adami had some interesting observations about Palo Alto Networks (PANW) a web security stock that he has been uniformly bullish on, despite valuation for most of the past year due to what he feels is one of the strongest secular trends in computing in decades, internet security. From his email this morning:

in June of 1983, War Games with Matthew Broderick was released. Broderick wasn’t a household name as Ferris Bueller’s Day Off was still three years away. However, fresh off her performance in Bad Boys, a young Ally Sheedy was also in the film, and that was enough for me. Well, yesterday’s hack of CENTCOM got me thinking of War Games and how yet again, life imitates art.

For quite some time, we have been steadfast in our view on a number of cyber security stocks. My personal favorite has been, and continues to be Palo Alto Networks (PANW). In 2014 this stock began the year with the stock around $57.00 while ending the year around $122.50. Back of the envelope math puts that at around a double. Now, if you are looking for a value play, PANW is probably not for you. On just about every metric one can look at, this is an expensive stock. However, if you are looking for a company that the stars may have perfectly aligned for, PANW just might fit the bill. Last week, prior to this CENTCOM hack, RBC Capital initiated coverage of Palo Alto Networks with a buy rating and a $145.00 price target. The analyst said, “it is seeing strong gains amid hacker attacks” and it was “displacing rivals and has an opportunity to exceed expectations.” As much as I would like to believe that yesterday’s hack of CENTCOM was a “one off”, the reality is this is probably going to become the norm. If you are a CEO of a company, you can cut costs all you want, but you had better not try to get things on the cheap when it comes to cyber security.

Today, PANW will be presenting at the Needham Growth Conference at 12:45 p.m. here in New York City. Tomorrow, they will be on a UBS Software Tour in Silicon Valley. Again, in my opinion, these cyber attacks are not going away any time soon. Every negative headline is a positive for PANW.

I think that it is all also important to note that the President’s State of the Union address on Tuesday Jan 20th is expected to focus a bit on cyber-security.  PANW’s 123% gains in the last incorporates a good bit of the enthusiasm around the stock, as does its valuation, at  173x expected 2015 earnings, and 12x sales:

PANW 1yr chart from Bloomberg
PANW 1yr chart from Bloomberg

But options prices look fairly cheap, and if you were inclined to buy the stock at current levels, I would suggest that 30 day at the money implied vol of only about 37% is as cheap as it has been in a long time, making the prospect of expressing directional view with long premium quite attractive on a risk reward basis:

PANW 1yr chart of 30 day at the money IV from Bloomberg
PANW 1yr chart of 30 day at the money IV from Bloomberg

One main reason for the relative cheapness for options prices is that for one, despite the stock’s gains it has not been particularly volatile, with 30 day at the money realized just 25%.

BUT for those who think the stock grinds higher over the next five weeks…  the  the March 130/150 call spread offered at ~$5.50 (stock ref $127) doesn’t look too bad. It has a break-even at $135.50 and a max gain of $14.50 11% higher in the stock.