FA Alpha Daily

Finally, a cybersecurity company with a competitive advantage

In today’s digital age, cyber threats have grown increasingly sophisticated, making cybersecurity a top priority for businesses worldwide. Zscaler (ZS) has emerged as a leading player in this crucial market by pioneering a novel approach and incorporating AI and machine learning to enhance cybersecurity. In today’s FA Alpha Daily, we explore Zscaler’s effort as a key player in driving innovation through its cutting-edge zero-trust approach.

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Cybersecurity has become an essential part of doing business in today’s world.

With the rise of remote work, cloud adoption, and increasingly sophisticated threats, organizations need robust security solutions to protect their data and infrastructure.

Global phishing attempts increased by 60% in the last year, and phishing attempts that targeted the finance and insurance industry increased by 400%. Furthermore, 56% of the companies reported having one or more VPN-related attacks in the past year. Also, IoT malware attacks increased by 400%.

The global cyber security market size was valued at $172 billion in 2023 and is projected to reach $425 billion in 2030, exhibiting a 13.8% CAGR.

Zscaler (ZS) has emerged as a dominant player in this critical market by pioneering a new approach to security called zero trust.

Traditional network security relies on firewalls that assume networks can be divided into trusted inside and untrusted outside zones. However, with employees and devices located anywhere, this inside/outside model no longer applies.

The company introduced a zero trust architecture that eliminates implicit trust and instead verifies every user, device, application, and transaction before granting access.

Rather than routing all traffic through on-premise appliances, Zscaler’s cloud-native platform securely connects users directly to applications, regardless of location.

This provides significantly better security than legacy firewalls while also lowering costs through massive economies of scale. As the world’s largest security cloud, the company processes over 400 billion daily transactions through its more than 150 data centers globally.

Zero trust has become a critical strategy for organizations to securely enable remote work and cloud adoption. Gartner estimates that by 2025, 60% of enterprises will have implemented a zero trust approach.

The company’s zero trust solutions not only provide better security than legacy firewalls but also a superior user experience.

This has helped Zscaler achieve the dominant market position, with over 50% of the Forbes Global 2000 now trusting it to secure their networks and users.

Unlike legacy vendors, Zscaler was built from the ground up as a cloud-native platform. This allows it to continuously innovate and stay ahead of the competition.

For example, its AI and machine learning capabilities like Zscaler AI and Zscaler Digital Experience enhance security, visibility and performance.

This innovation advantage, combined with its massive scale and brand leadership in zero trust, makes it extremely challenging for competitors to displace Zscaler.

The company’s financials demonstrate the power of its business model. In Q3, revenue grew 32% YoY while increasing the gross profit margin by 140 bps. Billings, a leading indicator of future revenue, grew 30%.

The company also managed to keep its clients with having 116% dollar-based net retention rate.

However, the market has yet to fully grasp the profitability and potential of Zscaler. Many investors perceive the company as unprofitable, not realizing that it has already achieved a positive margin…

Uniform earnings margin increased to 8% in 2023 from (2)% in 2019.

With the zero trust market still in its early growth phase and cybersecurity demands only increasing, Zscaler looks poised to deliver continued strong financial performance for the foreseeable future.

While the stock has appreciated significantly from its pandemic lows, it may still be undervalued relative to Zscaler’s long runway for profitable growth in a large and expanding market.

Best regards,

Joel Litman & Rob Spivey
Chief Investment Strategist &
Director of Research
at Valens Research

The Uniform Accounting insights in today’s issue are the same ones that power some of our best stock picks and macro research, which can be found in our FA Alpha Daily newsletters.

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