Shorting PANW ($52) - Part 2

• PANW’s own sec filings are opaque with respect to revenue generation and recurrence. PANW’s markets itself as a game-changer, with the implication that it can pull and retain clients from existing competitors such as CHKP.

• Services after the initial sale is only 1 year, and PANW admits it cannot predict renewal rates – is PANW’s customer base churning? Even after launching their Next-Generation Firewall in 2007 and with 5 years’ worth of data, PANW does not disclose renewal rates:

“…existing end-customers that purchase our subscriptions have no contractual obligation to renew their contracts after the initial contract period, which is typically one year, and we cannot accurately predict renewal rates[i]”

• Furthermore, their marketing pictures at the top of the recent prospectus “cumulative” end-customer counts, not current/ongoing:

From all this, the question is – how quickly is PANW running through old and new customers? I believe it is far less than the CRM/SaaS like rates, and more like traditional hardware with a far higher churn component.

To be fair, this is a tougher split (cumulative vs. on-going) customers, and the rest of the prospectus doesn’t say cumulative when referring to the 9,000 customer number. Is PANW counting initial appliance buyers (who do not renew) as part of their customers?

• Finally, PANW sells mainly through 3^rd party channel partners (distributors/resellers)[ii], and unlike competitors showed a decrease in revenue in a traditionally strong quarter (ending in January 2012).  

Again, from the recent prospectus:

We rely on third-party channel partners to sell substantially all of our products, and if our partners fail to perform, our ability to sell and distribute our products and services will be limited, and our operating results will be harmed.  

While not unusual, the lack of detail about these distributors (compared to say CHKP, which breaks out % of top 10[iii]) and the relative opaqueness invites “stuffing” of the distributors, where PANW ships excessive product in one quarter (or more) to artificially inflate revenues. This is similar to the M. Block/GMCR relationship shown by Greenlight[iv].

To be fair, I have not found direct evidence of the above, but when we look at sales on a quarter-by-quarter (from a Forbes article[v]), we see that PANW had weaker sales in a traditionally strong quarter for its competitors:

	Q3 2011	Q4 2011
Check Point	310.00	356.68
change (qoq)	0.55%	13.09%
Fortinet	103.00	116.40
change	9.42%	11.51%
SourceFire	36.16	53.20
change	42.31%	32.03%
Palo Alto Networks	57.11	56.68
change	29.57%	-0.76%

The reasoning is that companies push their sales force to sell at year-end, boosting sales. Yet, PANW is unable to grow/compete? This seems to be on purpose, as PANW is the only company among its major competitors (above) that has a year-end not in December (PANW’s in July, around its IPO).

That begs the question – did PANW purposely go public in July and have a July fiscal year-end to gloss over their December weakness and instead focus on temporarily strong year-over-year comparisons?

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[i] Prospectus pursuant to Rule 424(b)(4), October 17, 2012, page 15

[ii] Prospectus pursuant to Rule 424(b)(4), October 17, 2012, page 17

[iii] http://www.sec.gov/Archives/edgar/data/1015922/000119312512155119/d229899d20f.htm

[iv] http://www.reuters.com/article/2012/07/02/us-usa-greenmountain-mblock-idUSBRE8610YB20120702

[v] http://www.forbes.com/sites/richardstiennon/2012/04/18/tearing-away-the-veil-of-hype-from-palo-alto-networks-ipo/