PANW’s AI Security Push in 'Platformization,' Acquisition-Heavy Growth

**George Tsilis** (0:04)
All right, thanks, and welcome back to the Tech Corner. I'm George Tsilis, Senior Markets Contributor here with the Schwab Network. On today's edition, we're going to be covering Palo Alto Networks. Now, Palo Alto is one of the world's largest cybersecurity companies, providing security across enterprise networks, cloud infrastructure, endpoints, operations, identities, and increasingly AI applications as well as AI agents.
The company originally built its business around next-generation firewalls, but it has evolved into a much broader cybersecurity platform designed to consolidate many individual security products under one vendor. Following several major acquisitions, Palo Alto is now increasingly organizing the company around three broader platforms, network and AI security, identity security capabilities, as well as cloud security, software, and support services. Now, from the competitive landscape, some of the pure players in the space include CrowdStrike, particularly endpoint security, as well as security operations, Fortinet, which is in firewalls and network security, and Zscaler, which is in zero trust network access. The company also competes with Microsoft and Cisco in broader enterprise security. Now, when it comes to unique value, Palo Alto's primary competitive advantage is what management calls platformization. Instead of a large corporation buying separate cybersecurity products from 10 or 20 vendors, Palo Alto wants customers to consolidate those functions on a much smaller number of integrated Palo Alto platforms. That can lower complexity, reduce integration problems, and allow security information collected in one part of the organization to improve threat detection elsewhere. This becomes particularly important with artificial intelligence. As enterprises deploy AI applications and autonomous agents, Palo Alto can potentially secure the network the agent operates on, the cloud infrastructure it accesses, the endpoints it uses, as well as the identity and permissions assigned to it. In essence, the company is attempting to become less of a collection of cybersecurity products and more of an enterprise-wide security architecture. Now, let's take a look at some most recent news for Palo Alto. Just going back to this week on September 1st, the headline numbers that were posted by the company for fiscal Q4 2026, were particularly strong. Q4 revenue reached 3.41 billion, up 34% year-over-year, beating the roughly 3.35 billion-dollar estimate. Full-year fiscal 2026 revenue reached 11.48 billion, up roughly 24% from 9.22 billion from last year. Next-generation security average recurring revenue reached 9.1 billion dollars, up 63% year-over-year, and on-gap EPS came in at $1.02 versus roughly 98 cents estimated, which is also higher compared to 95 cents from the year earlier. However, when we narrow down and look at gap earnings results, they were much weaker. Palo Alto reported a $282 million gap net loss, or about 35 cents a share loss, compared to a $254 million in gap profits in the same quarter last year. Now, one of the reasons for the gap net loss was the announced acquisition of Consul, an AI native platform designed to allow companies to create agentic workflows using natural language. Therefore, acquisition-related costs and other adjustments contributed significantly to the gap between gap earnings or unadjusted earnings as well as the adjusted earnings. Now, aside from the news, let's look at some other positives for the business. First off, the company reported strong organic growth in its next-generation security portfolio, accelerating at double-digit rates, reflecting robust platform adoption and deepening customer commitments. The company's platformization strategy has resulted in high customer retention. The company posted a net revenue retention rate of greater than 120 percent, and rapid expansion in multiple product deals, underpinned by its effective integration of major historical acquisitions like CyberArk and Chronosphere.
Management has consistently guided and delivered increasing remaining performance obligations, also known as RPOs, which reached $18.4 billion for the quarter, up 36 percent year-over-year. This signals strong forward revenue coverage, validating the long-term potential of its consolidated security platform. Now, profitability for the business is also strong. For example, Palo Alto's gross margin is about 72 percent of sales, higher than the sector median, which is around 50 percent.
The company's levered free cash flow margin also stands at 34 percent, which is far ahead of the sector's 11 percent. The company also generated approximately $1.3 billion in adjusted free cash flow in Q4 and finished fiscal year 2026 with a very strong 38.4 percent adjusted free cash flow margin.
Now, this is important because it indicates the business generates strong profits and cash flow from its operations. Now, despite many positives for the business, we always have to cover some concerns as well. The most important issue underneath the earnings report is the 63 percent next-generation security average recurring revenue growth, which is not necessarily purely organic. Palo Alto Networks share count has also increased significantly about 15 percent over the last year largely due to these acquisitions and mention, which has constrained near-term EPS growth despite robust revenue expansion leading to weaker per share profitability. Also, heavy reliance on mergers and acquisitions poses integration risks and has resulted in periods of margin contraction, particularly with large deals like CyberArk, raising concerns about sustained organic growth. Valuation also remains a major concern. There's a company currently trades at approximately 78 times board earnings, which is nearly a four times premium to the sector median on several metrics, leaving little room for error if growth or margins do not meet investors' expectations.