This Cybersecurity Competitor Is Promising but Pricey

In expanding our cybersecurity coverage, we recently initiated on no-moat Zscaler, a cloud security name that went public back in March. Zscaler competes with Symantec and Cisco. We think Zscaler has impressive technology, and to understand the value proposition of this business, we need to understand the transitions that are occurring across the software and network security names that we cover.

Years ago, enterprise applications, such as Oracle or even Microsoft Office, sat in the enterprise's data center. Corporate personal computers would connect to that data center to access applications and the enterprise's security stack sat in the data center. That was essentially the drawbridge to access the open Internet.

Today, we are seeing two changes. First, applications such as Salesforce, Dropbox, and now Office 365, are sitting in the open Internet; second, we have an increasingly mobile workforce. Thus, if a regional offices need to access those cloud-based applications, they are no longer in the data center, so there is a muted rationale for an enterprise to continue paying for MPLS technology to back haul that traffic.

Zscaler lets those regional, local, or traveling users get an entire security stack in the cloud to access those applications. Zscaler allows employees to safely and securely access Internet destinations or SaaS applications, while being protected by firewall, advanced threat protection, and sandboxing among others.

Zscaler went public back in March. Their founder, Jay Chaudhry, has founded and sold four network security businesses in the last two decades before founding Zscaler. Even with our 30% compound annual growth rate expectations for this business and modeling solid margin expansion over the next decade, our valuation sits below where the stock has largely been trading post-IPO. We still think the firm has impressive technology and is a burgeoning cybersecurity competitor, but we think the valuation has gotten ahead of itself.