Event: Palo Alto Networks (PANW) reports their fiscal Q3 results after the close. The options market is implying about an 8% one day move tomorrow, which is rich to the 5.6% 4 qtr average one day move and the 5% average one day move since its 2012 IPO. I would add that the stock has risen the day following its last 11 earnings reports and has only declined two times after reporting quarterly earnings since Dec 2012.
My View on Valuation: Earlier today I was asked by a subscriber if I had a view of on-the-line security vendor, but to be honest I have not really looked at the stock since my earnings preview back in late February (here). Taking a fresh look today, here was my response:
My concern with PANW has always been valuation, and what seemed like a universal bullishness about the stock and the company’s prospects. on an adjusted basis, PANW is expected to earn 1.66 per share in fiscal 2016, on a GAAP basis, the company is expected to lose 2.29, thats a greater GAAP loss than fiscal 2015’s $2.02, despite an expected year over year sales increase of nearly 50%, what the hell are these guys spending on customer acquisition??There is obliviously some sort of premium built into the stock for potential take-over as they are one of few security vendors with more than $1 billion in sales, I am just hard-pressed to see who could make such and expensive acquisition, that would likely have to be well above $15 billion (current market cap $13 billion, high was nearly $18 billion last July).Technically the chart is a bit of a train-wreck, just below the downtrend from the Dec highs, and below a key support level at $145:
Putting the fairly massive range of the one year chart in some perspective ($200 to $111) it makes sense to take a gander at the stock’s performance since its mid 2012 IPO at $42. Earlier this year PANW clearly broke the uptrend that had been in place from the 2013 lows, and is now in a fairly well defined downtrend:
My View into the Print: Despite the stock’s 17% ytd decline and 27% decline from its 52 week an all time highs, Wall Street analysts are overwhelmingly positive with 38 Buy ratings, only 3 Holds and NO Sells, with an average 12 month price target $195. That is shockingly scary, especially when you consider the stock trades about 90x current fiscal year adjusted earnings, and expected 9.5x sales. Bull markets help masquerade massive money losing endeavors like PANW (despite huge revenue growth) but that playbook got more complicated at the start of 2015.
If I were long the stock it would be because I think some large enterprise hardware and/or software vendor (who is not growing) may pay an even more bizarre price for a company like PANW that is growing. In that instance, like any takeover candidates I would want to define my risk. If the company’s sales growth and or margins decelerate in a meaningful way, this stock is $100.
So how do you define risk in PANW?
In lieu of 100 shares of PANW (145) Buy the June/Sept 160/150 call calendar vertical for 9.25
- Sell 1 June 160 call at 2.25
- Buy 1 Sept 150 call for 11.50
Rationale – Ideally PANW is higher but not through the 160 call strike by June expiration and the short call can then be rolled out and hopefully up, to continue to finance the September call (and reduce premium at risk). The options are pricing in about an 11 dollar move on the event and the 160 strike is about 10% (and 15 dollars) higher than here. So selling that call is outside the expected move. It finances owning the September near the money call. Risk is to the downside as the 9.25 is representing about 25 deltas, so if the stock goes down significantly a lot of that premium paid could be lost. But the most that can be lost under any scenario is 9.25. That’s less than the implied move into tomorrow, and this trade has potential to be profitable all the way out to September.