Shorting PANW ($52) - Part 3, final

• Finally, insiders have sold the equivalent of 1x ttm revenues in last year only four months after ipo. A secondary offering this past month (with no money flowing to the company itself) so close to ipo implies, “why the desperation?” PANW has allowed insiders to circumvent the original lockup restrictions in place only 4 months before.  

Date	Insider	Shares	Transaction	Value*
TBA, filed 10/17/2012	Many sellers	4,800,000	Current price is 52	$  249,600,000
10/22/2012	BONVANIE RENE- Officer	37,500	Sale at $60.48 per share.	$       2,268,000
10/22/2012	BATRA RAJIV- Officer	185,500	Sale at $60.48 per share.	$    11,219,040
10/22/2012	LANFRI WILLIAM A- Director	30,000	Sale at $60.48 per share.	$       1,814,400
10/22/2012	MCLAUGHLIN MARK D- Officer	46,000	Option Exercise at $10.77.	$          495,420
10/22/2012	MCLAUGHLIN MARK D- Officer	46,000	Sale at $60.48 per share.	$       2,782,080
10/22/2012	ZUK NIR- Officer	200,000	Sale at $60.48 per share.	$    12,096,000
7/24/2012	BATRA RAJIV- Officer	202,000	Sale at $39.06 per share.	$       7,890,120
7/24/2012	ZUK NIR- Officer	350,000	Sale at $39.06 per share.	$    13,671,000
			Total	$  301,836,060

More generally, secondary offerings close to ipo have been a reliable predictor [i] of future price declines. Examples with 30%+ declines from sale price include Bazaarvoice Inc (BV), Zynga, Inc. (ZNGA). The rationale is that unlike planned insider selling, insider selling that breaks lockup restrictions is a purposeful act – companies have to ask underwriters to sell renegotiate the earlier restrictions.

Final valuation

Trading at over 4,000 times ttm earnings, comparing earnings is not very meaningful because of the high stock compensation/expense. That by itself is very telling, echoing the stock expense issues of the dot-com era. Valuations make more sense on a revenue basis, on which PANW is still the most richly-valued at over 14x ttm price to revenues.

Comparable Companies Analysis ("Comps")
*Averages are unweighted
*As of 11/23/2012		Market Cap ($bil)	($bil)	($bil)	($bil)	($bil)
		Equity	Enterprise	Revenue	Revenue	Revenue
Companies	Price ($)	MCAP	Value1	2011 (A)	2012 (E)	2013 (E)
CHKP	46.01	9.38	7.93	1.25	1.35	1.45
FTNT	19.06	3.05	2.67	0.44	0.53	0.62
FIRE	47.15	1.42	1.25	0.17	0.22	0.26
Average		4.62	3.95	0.62	0.70	0.78
PANW	55.41	3.79	3.47	0.12	0.23	0.39
	Enterprise Value /			Consensus
	Revenue Multiples (x)			Estimated EPS ($)
Companies	2011 (A)	2012 (E)	2013 (E)	2012 (E)	2013 (E)
CHKP	6.36	5.87	5.47	3.17	3.48
FTNT	6.02	5.07	4.31	0.51	0.61
FIRE	7.55	5.71	4.74	0.81	1.00
Average	6.64	5.55	4.84	1.50	1.70
PANW	29.26	15.41	9.01	#N/A	#N/A

(above data), PANW is July vs Dec of other years[ii]

PANW is priced at 9x 2013 ttm revenues, a 100% premium to all its competitors (9.01/4.84). The difference is even more absurd when looking at earnings (which is not even meaningful). I believe this premium is unjustified given the questions about PANW’s ability to replace CHKP products and renew revenue.

Risks

-Acquisition by CHKP or other competitor (~20-30% from current levels)

-Acceleration of growth and monetization as PANW takes market share from CHKP.

Implementation

-This is a highly volatile stock, and can easily move 20-30% to the upside before the thesis holds, and given the correction in the broader stock market, now is a time when PANW is highly vulnerable to upward bursts (e.g. PANW two Fridays again).

Conclusion

While the picture remains incomplete, I believe there is a compelling case to be short to the 20-25$ range. This is conservative, and only assumes the market revalues the EV/Revenue premium vs. its competitors.

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[i] http://online.wsj.com/article/SB10000872396390443696604577647922960428402.html

[ii] Morningstar.com, Yahoo Finance