Zscaler (NASDAQ:ZS) shares fell Thursday on news that its COO William Welch will be departing the company. In a press release submitted to the SEC, Welch stated that he was leaving “to take on a more senior role at a leading technology company,” and declared that Zscaler “is extremely well-positioned.” Zscaler CEO Jay Chaudhry said that Welch’s departure would have no impact on their third quarter financial results which will be released on June 6.
Yet despite these reassurances, Zscaler’s shares fell by almost 10 percent to finish at $27.57 at the end of trading Thursday. Its all-time post IPO low was $26.54. Overall, Zscaler’s shares declined shortly after reaching an initial spike of $33 in March, and have hovered from $26 to $30 ever since.
This initial decline is likely due to negative sentiments about Welch’s departure as opposed to anything concrete. The stock will likely go back up shortly and continue to stay around its present value until the next quarterly financial results report. Zscaler itself appears to have a bright future, but its stock value even factoring in the recent decline is already on the high end of what it should be valued.
Zscaler’s Potential Future
Zscaler is a technology company which proposes to change how businesses approach the matter of cloud security. Businesses today are more worried about whether the cloud is truly safe and whether cloud providers can be totally trusted. Protecting the on-premises corporate network is irrelevant in a world where more workers are storing critical data on the cloud and are not working directly in the office.
Zscaler uses its cloud network to route the traffic of its clients through its data centers and rejects traditional on-premises security appliances. The end result is a safer, more useful security platform that will almost certainly grow in popularity as more businesses understand the importance of cloud security.
A look at Zscaler’s pre-IPO financial numbers shows its growth potential, as revenue increased from $53 million in 2015 to $125 million in 2017. Zscaler works on a subscription model, which is good for ensuring long-term sustainability. And while the company does report increasing net losses, this is not an immediate concern given its cash on hand. Emphasizing growth is the right strategy, and Zscaler could absolutely become a preeminent player in the highly important field of cloud security.
Overvalued
Everything listed above should make clear that Zscaler has a solid future and room to grow. But the company’s upside potential is already factored in, making this stock rather overvalued compared to its competitors.
For example, Zscaler at its current reduced share price has a market cap of about $3 billion, meaning a price-to-sales ratio of 24. By comparison, two of its main competitors in Cisco (NASDAQ:CSCO) and Symantec (NASDAQ:SYMC) have a price-to-sales ratio of less than five. Furthermore, Barron’s reports that Deutsche Bank’s Gray Powell notes that “ZS is trading at almost 12x 2019E EV/sales vs the top tier of the 20+ high growth peers we track at closer to 8.0x 2019E EV/sales.”
Yes, Zscaler has more room to grow than its competitors, but this potential is already factored into the stock. And the company does face some real challenges. In addition to the increasing net losses as well as negative cash flow, Zscaler also faces a lawsuit from Symantec who alleges that Zscaler has infringed on their intellectual rights. And as more businesses grow more concerned about cloud security, there is no doubt that competition will increase.
There is certainly a lot to like about Zscaler’s long-term future. But a good company can still have an expensive valuation which makes buying it an unnecessary gamble.
A Betting Man’s Stock
Zscaler is very much a high-risk, high-reward stock given how its expensive valuation clashes with its potential and revenue growth. That risk did get a little smaller with the recent share price decline thanks to Welch’s departure, but I do not expect this temporary dip to last long enough for most investors to consider taking advantage of it.
It is possible that investors buy now, see Zscaler report good financial numbers next month, and watch as their investment soars. But it is just as possible that Zscaler stumbles early on and investors find out they should have waited later to buy.
In the immediate short term, investors should not take anything away from Welch’s departure and view it as a temporary, meaningless blip. Holding is the best course of action for now, and investors should wait for more information such as Zscaler’s upcoming earnings report.