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Questor: this American ‘cloud computing’ firm is growing at astonishing speed. Buy
Questor share tip: Zscaler has a unique solution to the challenges posed by the move of software such as Office from companies’ own premises to the internet
What are we to make of a business that becomes profitable too early?
It’s common for even the most successful technology start-ups to make losses in their early years as they reinvest everything they earn in growth. Often the money is spent on hiring staff to cope with the rapid expansion.
But Zscaler, a specialist in security for “cloud” computing, is growing so fast that it cannot hire staff quickly enough, according to one investor in the firm. The money earmarked to pay the new employees is instead making the company profitable ahead of schedule.
“Of all cloud computing businesses the one I am most enthusiastic about is Zscaler,” said Walter Price, who holds the stock in his Allianz Global Technology investment trust. “It has just turned profitable – it wasn’t meant to be yet but it is growing too fast to hire enough sales staff to sell the service. There is a lot of demand ‘pull’ from customers telling other potential customers. This is pretty unusual.”
He said Zscaler was also unusual in that its cloud security service tended to save customers money, whereas normally computer security was seen as a kind of “tax” on everyday business. Price explained how this was possible.
“Many businesses are moving key software to the cloud. One example is Microsoft Office. Previously it would be installed on servers in the head office, to which branches would connect over secure lines, and the HQ would handle security,” he said.
“Now companies are switching to the cloud-based version, Office 365, and the traditional way to deal with this would be for branches to continue to communicate with the head office, which would have the connection to the internet-based Office 365.”
He added: “But Office 365 and other cloud services generate a lot of traffic and routing it all via the HQ would require two sets of lines and create a bottleneck. Zscaler’s answer is to have branch offices communicate directly to the cloud via its servers, which deal with security threats. This is much more efficient.” Data from mobile workers is handled in the same way.
Price said no competitors could offer a similar solution and demand was being led, unusually for a start-up, by big multinationals such as Siemens, Philips and Bombardier.
- Read Questor’s rules of investment before you follow our tips
“Amazon and Microsoft are customers and are recommending Zscaler as a means to get people to buy Office 365 and Amazon Web Services,” he added. “It’s growing at 50pc a year with the largest companies in the world as its customers.
"It’s the biggest companies that need it and it can pay for itself in three or four months. These very large companies are saying, we need to transform to the cloud and do the same for security. Most rivals say you just need a bigger security installation but that way costs an order of magnitude more.”
Shares in the Nasdaq-listed firm are “extremely expensive”, he said, but added: “I think when people look at the valuation they don’t appreciate that it will continue to grow very fast and get a lot more customers. It will have $1bn of sales within three years.”
Questor says: buy
Ticker: Nasdaq: ZS
Share price at close: $66.36
Updates: Twilio, NetApp and Sophos
We have discussed these three technology firms with Walter Price in the past. He is happy to hold Twilio and NetApp, which are both American, but somewhat disenchanted with Sophos, the British antivirus company.
He said Twilio was at the centre of a transformation of call centres as they began to handle different methods of communication such as social media. Its new call centre software fetched much higher prices and was much “stickier” because customers had built future call centres around it, he added.
Price said NetApp’s shares were now “inexpensive” following disappointing sales figures and he remained optimistic. “It has developed a new file system for Amazon, Google and Microsoft that will make cloud computing quicker, but it has taken six months longer than expected to get it up and running,” he said. Both stocks are a hold.
Sophos has “not executed very well”, Price said, although he has retained a small stake. Our advice is to sell and switch to one of the more promising tech names mentioned here.
Questor says: hold, hold, sell
Ticker: NYSE: TWLO, Nasdaq: NTAP, SOPH
Share prices at close: $129.73, $69.13, 342p
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