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Why Palo Alto Networks Has Spent Over $1 Billion on Acquisitions

Nicholas Rossolillo, The Motley Fool

Over the last two years, Palo Alto Networks (NYSE: PANW) has been on a tear. Not only has the stock nearly doubled in value over the last 24 months, but the company has also been on an acquisition spree. The cybersecurity outfit made its largest yet just ahead of its 2019 fiscal year second quarter, fast-tracking its move into artificial intelligence capabilities as customers deal with increasingly complex cyber threats from the bad guys.

The price tag

Palo Alto Networks recently announced its intent to purchase privately held Demisto, based in Cupertino, California. Total consideration is $560 million payable in cash and stock, an impressive sum given that the smaller security company was founded less than four years ago in 2015.

That's the fifth buy of a smaller peer Palo Alto has made since the beginning of 2017. The total price tag is over $1 billion, a big chunk of change considering Palo Alto's current enterprise value is $21 billion. It's been money well spent, though, helping the company expand beyond its legacy of providing firewalls (a system designed to prevent unauthorized access to a network). A few years ago, booming growth in cloud computing necessitated the expansion in that direction. The result was a 29% and 47% increase in revenue and adjusted earnings during the 2018 fiscal year, and revenue and adjusted earnings so far in 2019 are up another 31% and 48%.

Company

Acquisition Amount

Company Description

Demisto

$560 million

Security orchestration, automation, and response services

RedLock

$173 million

Cloud computing security services

Secdo

Unconfirmed for $100 million

Israel-based data collection and visualization for endpoint attack detection and response

Evident.io

$300 million

Cloud computing security services

LightCyber

$105 million

Automated machine learning behavioral analytics technology

Data source: Palo Alto Networks.

What Palo Alto Networks got for its money

Though Palo Alto has been shelling out big sums for smaller rivals, cybersecurity is a fast-evolving industry. Demisto will be an especially ambitious purchase, but CEO Nikesh Arora said the small firm is expected to post at least $50 million in sales this year. That's huge growth for a four-year-old endeavor.

An artist's illustration of AI: a human silhouette filled in with computer data.

Image source: Getty Images.

And that's exactly why Palo Alto was willing to pony up. Demisto is a specialist in security orchestration, automation, and response (SOAR) services, an emerging segment in the cybersecurity industry. Big data company Splunk (NASDAQ: SPLK) also made several buyouts last year in the same area. Automated responses to digital threats powered by machine learning (a type of artificial intelligence) is an increasingly important need for organizations as they navigate the digital age, and Palo Alto wants to accelerate its strategy in AI and automation.

It's yet another evolution in the digital space as companies around the globe slowly migrate away from legacy operations. Over the last two years, Palo Alto has transformed itself into a diverse provider of security services to protect that transformation. First was a focus on securing cloud-based operations, and now Demisto helps the company's customers learn from its data and automatically respond to anomalies. In response to the ever-shifting landscape, management said during its second-quarter earnings call that more acquisitions could be forthcoming. It's a good move to capture market share as the industry responds to nefarious activity and changing needs from its customers -- one that Palo Alto can afford, as it has over $2.8 billion in cash and short-term investments on the books.

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Nicholas Rossolillo owns shares of Splunk. The Motley Fool owns shares of and recommends Palo Alto Networks and Splunk. The Motley Fool has a disclosure policy.