Hot Hot Hot! ZScaler Ignites the IPO Market
ZScaler (NSDQ: ZS) took the market by storm last week. After raising its price range several times, the IPO finally priced at $16. The stock opened at $27.50 and climbed higher all day until it closed at $33, close to the highest price of the day.
It’s been some time since the market has seen such a hot IPO. There have been 33 IPOs this year and almost half of them are down since the day they were priced. Only one deal, Armo Biosciences (NSDQ: ARMO), is up more than ZScaler. That stock opened up 170% on its first day of trading and has been creeping lower ever since.
ZScaler has all the highlights of a hot IPO. Revenue growth is in the high 50% range and has been accelerating in recent quarters. Losses are piling up just as quickly as the company hires more salespeople to flood the market.
Its industry, cloud security, and its model, software-as-a-service, are the two most popular buzzwords in the market right now.
(chart courtesy of BigCharts)
Cloud security is all the rage and for good reason. Applications are being moved out of IT warehouses and into the cloud. Users have moved out of corporate offices and expect 100% mobility. They are tethered to their smartphones, tablets, and laptops and expect the software programs that they use to be available to them seamlessly and securely.
For example, I work in a home office, hundreds of miles away from the corporate hub. If I cannot access Microsoft word or any of the applications used to research stock ideas, edit and publish documents, then I would be a pretty unproductive worker.
ZScaler specifically notes the migration of Microsoft 365 to a web-based application as one of the reasons cloud security has become more critical. Microsoft’s workhorse program used to be downloaded to your computer, where it sat for years, growing slightly outdated but nevertheless useful.
This was a good news/bad news situation for users. The good news was that you paid just once for the download of Microsoft 365 and could use it forever. The bad news was that your software was never updated, so new features could not be enjoyed without buying the “new” version of the software.
Microsoft (NSDQ: MSFT) (and almost every software company that exists) realized it could garner a perpetual stream of income by switching to a subscription service. The “old” version of Microsoft 365 no longer exists. New users must pay anywhere from $70-$100 per year for access to the program. This new model is referred to as SaaS, or subscription as a service.
Unlike other applications that sit in the cloud and are used only intermittently, MS 365 programs are used continually by workers. This creates a strain on a network and makes monitoring the security of the data being sent back and forth a difficult task.
ZScaler’s security products are designed specifically for distributed use. Instead of redesigning old software to become useful in the cloud, starting with cloud infrastructure can help ZScaler create more robust solutions.
ZScaler does not lack competition. Cisco (NSDQ: CSCO) and Symantec (NSDQ: SYMC) and are noted as serious contenders in the cloud security market. But they sell other products as well, products that aren’t growing as fast as cloud security so that total revenue growth is bogged down by this mix.
Palo Alto Networks (NYSE: PANW) is a pretty good comparison for ZScaler. Its revenue growth has slowed to 27% from 48% in 2016 and 55% the year before but on a significantly larger base than ZScaler.
I wouldn’t bet against ZScaler. Founder and CEO Jay Chaudhry has started and sold four security companies in the span of his career. He owns almost one-quarter of the shares in the company and is not selling a single share on the deal. In fact, ALL of the 16 million shares offered in ZScaler’s IPO are newly issued ones. Not one share is being sold by insiders. This is an incredibly bullish sign.
Savvy investors look at where the “smart” money is stashing their assets. There are few technology investors smarter than Jay Chaudhry and his money is betting on ZScaler. (As an aside, Brain Trust Profits, a service offered by Investing Daily, does just this- it tracks the movement of smart money so you can discover new stock ideas.)
The company did not need to issue an IPO, it had enough cash on hand to operate privately for some time and the deal is backed by the dynamic duo of underwriters; Morgan Stanley and Goldman Sachs.
The most obvious play on the ZScaler IPO is to find lesser known companies operating in the same space. ZScaler now trades at 20 times the forward estimate of revenue (not profits, the company has yet to generate profits). This generous valuation leaves lots of room for smaller players to enjoy upside.
My Profit Catalyst Alert service has recommended one of these smaller players since late 2016. The stock is up 97% since then and up 33% year to date, partly on exuberance for the cloud security market.