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Palo Alto Networks' Slide Should Fuel Merger Interest

Richard Saintvilus

NEW YORK ( TheStreet) -- If there were any questions as to whether or not Wall Street's honeymoon phase with enterprise security darling Palo Alto Networks was over, the stock's 15% decline following what was on balance a decent third-quarter earnings report should have erased these doubts.

While Palo Alto has indeed pioneered what I believe is next-generation security, there was always concern about the company's long-term profitability. Management's downbeat guidance didn't help matters.

Nevertheless, the company has one of the most innovative security platforms on the market, with a pristine balance sheet. With the stock down 35% from its all-time high and with no bottom yet in sight, Palo Alto should begin to attract plenty of attention from names including Cisco or other established tech companies looking for top-line growth. In that department, very few can compare to Palo Alto.

Although the stock's performance since the announcement doesn't reflect it, Palo Alto's earnings report was actually pretty good. Investors chose to focus on the bottom-line miss while discounting the fact that revenue soared 54% year over year and 5% sequentially. This performance follows a second-quarter report where revenue surged 70%.

Granted, profitability wasn't overwhelming. The company reversed a profit last year by posting a loss of 10 cents per share on a GAAP basis, which spooked the weak hands. But the company managed to beat adjusted earnings per share of 6 cents by 1 cent.

We have to keep things in perspective here. It's not as if the entire sector has been knocking the cover off the ball. Palo Alto is still outperforming more dominant players like Fortinet and Check Point . Even Cisco, which is regarded as the leader in the sector, posted 5% revenue growth, while also issuing downbeat guidance.

In that regard, it would be foolish for Palo Alto to guide against the grain in a market that has yet to show meaningful signs of a rebound in tech spending. To that end, although both the top- and bottom-line outlook fell short of Street estimates, I think management's guidance was in line with overall sector.

It seems as if the Street would much prefer if Palo Alto suddenly switched from a top-line performer to posting bottom-line gains. But I think it's too soon. This is still a young company that is experiencing incredible growth. But Palo Alto is not immune to macro conditions.

Although Cisco spoke optimistically about a second-half rebound, it's anyone's guess when that's actually going happen. The recent 40% decline in the shares of Aruba Networks serves as a perfect example of what can happen when high expectations does not manifest itself into results.

After a 54% jump in revenue, could it be possible that Palo Alto management is being overly cautious? Perhaps. But it's certainly justified. But investors have to realize that this doesn't change the fact that the company has products and services that enterprise customers are willing to pay handsomely for.

With assets that helps corporate clients secure their network while safely enabling CIOs to manage the growing number of applications, I believe Cisco and possibly Oracle will eventually pony up the cash for Palo Alto. And I think it's just a matter of time, especially if the stock doesn't find a floor soon.

At the time of publication the author had no position in any of the stocks mentioned.

This article was written by an independent contributor, separate from TheStreet's regular news coverage.

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