Here's Why The Market Should Love Palo Alto's Q3

Palo Alto Networks Inc PANW reported its 3Q16 EPS in-line with expectations, despite a significant revenue beat. JPMorgan’s Sterling Auty maintained an Overweight rating for the company, while reducing the price target from $216 to $196.

Shares lost more than 10 percent after hours, with concerns over decelerating product revenue. Analyst Sterling Auty said, however, that this was a “myopic view” of the Palo Alto’s success, since it did not consider sustainable +30 percent revenue growth, driven by increases in subscription, margin expansion, and a 40 percent CAGR in FCF through FY18.

“The one pushback we understand from the market is the backend loaded nature of the quarter and comments about macro impacts, but with 61% growth in billings the execution has been unassailable, in our view,” Auty wrote.

Positives For The Company

Although Palo Alto’s EPS was in-line, this was due to the higher mix of subscription billings, “which generates upfront commission expense versus ratable revenue recognition,” the analyst pointed out. Moreover, the company generated best-in-class billings growth of 61 percent, driven by “an increasing uptake of the eight subscriptions PANW now has available.”

Palo Alto’s product revenue missed expectations. Management had been indicating a shift toward subscription revenue for several quarters. Auty commented that the Street had been slow to incorporate the shift, while adding that this strategy “offers greater long-term value given the margin profile and high renewal rates on this revenue stream.”