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TheStreet Open House

Why Palo Alto Is Oversold

Stock quotes in this article: PANW, CHKP, FTNT, IBM, CISCO

NEW YORK ( TheStreet) -- Another quarter is in the books for Palo Alto Networks (PANW) and it seems that all of the excitement surrounding the company's IPO has vanished. With the stock making new 52-week lows every other session, I'm beginning to wonder if the company will ever find a bottom.

Despite recent declines the stock is still priced at a premium relative to rivals such as Check Point Software (CHKP) and Fortinet (FTNT). On the other hand, a 30% drop in two months makes the shares very appealing at $49. But did the company do enough in its Q1 earnings report to convince investors that current valuation is anything but a trap?

It's hard to downplay a quarter during which revenue soared 50% year-over-year to $85.9 million and grew sequentially by 14%. Palo Alto also grew its customer base by 1,000 to more than 10,000 -- a pretty remarkable accomplishment for such a young company.

It seems that early investors have gotten satisfied with their gains which soared as high as 30% since its first day of trading. Investors are ready to move on. While I can also appreciate some possible tax selling, still, it's hard to dump shares of a company that is growing at a 50% annual rate.

Equally impressive, Palo Alto saw a 30% year-over-year jump in product revenue, which also grew 12% sequentially. Likewise services revenue soared 113%. These figures indicate that the company is stealing market share from the competition, which doesn't explain why the stock has been sliding.

Then again, profitability might have been a legitimate concern. Non-GAAP net income of $2.9 million during the quarter was considerably lower than the $5.6 million the company earned a year ago. From that standpoint, Palo Alto met its targets. But for a stock that trades at such a premium it's nonetheless disturbing that net income is trending downward.

It did not help investors' confidence that gross margins shed 217 basis points year-over-year, although the company did manage to improve gross margins sequentially by 70 basis points. Relative to expectations it was a good quarter, and management thinks the next quarter might be better.

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