Left Brain Thinking: Zscaler and Cybersecurity

Welcome to Left Brain Thinking, where creative investment ideas meet logical analysis. That's the hallmark of Left Brain Investment Research, where the analysts are looking for growth companies with the potential to double in 2 to 3 years and high-yield bonds with the potential for dramatic price appreciation. Today we're going deeper on cybersecurity stocks with Mark Hines, Managing Director at Left Brain Investment Research, and one of the firm's experts who you can see on January 7th at 5 PM Eastern Time in in the latest Fortune Makers Zoom event. Left Brain is dedicating this week's event to cybersecurity. So if you like what you hear now, go look for details at leftbrainir.com or search Left Brain Investment Research on eventbrite.com. Mark Hines, great to chat with you again.

Hey Chuck, I'm happy to be here.

So cybersecurity is the topic for the week. It was what we were talking about last week as well with Nolan Langford from Left Brain. And let's go a little bit deeper because, well, obviously it's been all over the news and it has generally been something that, that folks have said, you know, this is one of those areas that's benefiting from the pandemic. But at Left Brain, you guys are not thinking cybersecurity is a pandemic play. You're thinking cybersecurity is an everything play. Play, correct?

Yep, that's absolutely right. It is an everything play. Uh, you know, of course, cybersecurity did become a much bigger deal as part of the pandemic when everybody was sort of working from home, working remotely, the stay-at-home orders. So people are all of a sudden accessing all kinds of corporate and government information from home and different devices. So it became, uh, it became a really big deal, and a lot of focus was put on these cybersecurity companies. But in our view, this is not, uh, this is not a short-term phenomenon, right? This is a big long-term secular trend, and it's, it's not going away.

But as you're evaluating companies, are there some where you have the pandemic surge and others that you just have accelerated growth? And what I mean by that is you're looking for growth, those companies that can double in 2 to 3 years. If you get a company that gets ahead of itself because it's been pushed up by business tides. Well, at some point it will revert to the mean, it will regress, even if the business looks good. Are we looking, as you sort through the cybersecurity stocks, at some that, hey, this benefited and got ahead of itself, so I'm not expecting the growth? And then at others where you're going, the growth is here, they're just scratching the surface, and no, this isn't a surge, this is, uh, the beginning of a trend?

Yeah, no, I think it is a trend, right? This is not a discretionary item. Cybersecurity is really important to these companies, and a lot of the ones we're looking at are sort of software as a service. So you get into the company and then you have the land and expand strategy, right? For example, Zscaler, a stock we'll talk about today, once they get in with the company, it's a subscription-based service. And, you know, if you're the chief investment officer of a company, you're not going to get rid of your cybersecurity. It's a requirement, you've gotta have it.

So let's talk a little bit about Zscaler. Help us understand what it does and why it's particularly positioned well right now.

Sure, Zscaler is one of those classic left-brained stocks. Zscaler is a cybersecurity company, and what's special about Zscaler is it was born in the cloud, right? This sort of global digital transformation where everybody's moving their data to the cloud has been accelerated again by the pandemic, but it's going on, it's a long secular trend, and Zscaler is unique because it's a cloud-first platform. Everything's in the cloud. They have sort of this zero trust policy, which is really, really important to a lot of people. As I'm sure you heard, the SolarWinds hack that went on recently, where they're saying it was the Russians, right? Got into all kinds of government data and all kinds of corporate data because there were some security measures that were not in place. They were able to get away with some things that they shouldn't have been able to. And that combined with the pandemic really just draws attention to the importance of cybersecurity. So Zscaler is at the forefront. I said it's kind of a classic left-brain stock. Zscaler is growing very rapidly. It had over 70% sales growth in 2020. It's estimated to have over 30% sales growth in 2021. Has a very large total addressable market. That's one of the things we really, really like. So not only is it growing fast, but it has a really long runway to keep growing. It's a founder-led CEO. Jay Chaudhry founded the business, kind of a serial entrepreneur. He's had a lot of success with other companies that he's formed. He's a huge shareholder, owns something like 30% of the outstanding shares. So Zscaler is a company in the cybersecurity space that really stands out. It checks a lot of the boxes and it's really got a lot of room for long-term growth.

And obviously it has a tailwind from SolarWinds and Sunburst and whatever other names we're giving to data breaches. Just crazy that we have so many data breaches that we have to name them and then that the names become recognizable.

Yeah, I mean, it's really unbelievable. And what else is going to become really recognizable is I think a lot of these sort of stocks, these cybersecurity companies, you know, you mentioned our upcoming Fortune Makers event coming up this week. We're going to be highlighting 3 more of those stocks. I think last week Nolan talked to you a little bit about Tenable. I believe we've talked to you about CrowdStrike in the past. There is a roster of these cybersecurity companies and they are just on a path for rapid growth and it's going to continue for a while. So we're very excited about the investment opportunities in the space and we're very excited about our call that's coming up.

One of the things that happens for Left Brain, you guys are looking for organic growth. You guys are not, let's go buy a company hoping that it becomes a takeover play. You're not looking Not that you're going to object if somebody wants to pay a premium for a stock that you own, but you're not looking for that. And yet in cybersecurity, this business is nascent enough that you could see at some point some of the big computer players, whether it's the Microsofts and the Googles of the world or what have you, saying, you know what, I'm better off partnering or buying these folks than I am working with them outside. Do you believe we're going to see some shakeout that part of your look right now into cybersecurity is not just let's find out what's hot, but let's find out what's going to be here, what's going to be the survivor or what's going to be the one that maybe as a bonus gets taken out.

Yeah, I mean, we tend to be disappointed when a company gets taken out because that means that that shuts off the sort of long-term growth spigot for that company. But, you know, I think the best companies are going to rise to the top and they're going to do just fine as standalone businesses. These are companies that have very, very high gross margins. For example, Zscaler's gross margins are about 77%. They're spending a lot right now to meet the growing needs in the industry and to grow the business, which is exactly what they should be doing because the opportunity is so long. And I think, you know, these aren't companies that need to be taken over for support. These are companies that just have the massive growth potential as standalone companies to keep growing for a long time. Hopefully they won't get taken out or bought out by the big Microsofts of the world or anything like that. We're disappointed when it happens, even if it is at a premium, because again, it— then we have to find something else to do with the money, right? We don't think, you know, a trillion-dollar company is going to be growing as fast as, say, a $25 billion cybersecurity stock that leads its industry and is firing on all cylinders. So hopefully not a lot of takeouts and takeovers, but it certainly is a possibility.

There would be some investors who might be worried because, well, this stock in the last year has been from about $35 a share to well over $200 a share. It's back below that right now. Are you looking at ZS and thinking right now we're buying on a dip?

Yeah, I mean, a lot of these top growth stocks have taken a little bit of a breather as we've kind of finished up 2020 and started out 2021. And I think that's healthy because they have been on such a tear. I'm looking at Zscaler in the last one year is up 307%. It trades at around 52 times price to sales, just an extremely high number, but it becomes less high when you look at it in comparison to the growth rate. You mentioned they have over 30% expected sales growth for 2021. And again, with that large TAM, uh, the growth is going to continue for a lot of years. So I think it's warranted. You do have to pay up for some of the top businesses, especially when you've got this nascent industry with a long runway for growth. So you could look at the pullback in the last few days and couple of weeks here as an opportunity to buy. But I think in the long run, it's not going to make too much of a difference just because the long-term trend is higher and it's going to stay higher for a number of years.

It's Zscaler, ticker ZS. You can hear more about it and other cybersecurity stocks at the Fortune Maker Series event on January 7th. Mark Hines, thanks so much for joining me to talk about it.

Thank you, Chuck. It was my pleasure.

Left Brain Thinking is a joint production of Left Brain Investment Research and Money Life with Chuck Jaffe. Our conversations are not personalized investment recommendations but are designed to engage your brain. Please do your diligence before making any financial transaction. I'm your host, Chuck Jaffe, and you can learn more about my weekday podcast at moneylifeshow.com. Thanks to my guest, Mark Hines, Managing Director at Left Brain Investment Research, Learn more about the firm and its services and the upcoming Fortune Makers series at leftbrainir.com. They're on Twitter @leftbrainir. Left Brain Thinking is available every Wednesday. Find it and subscribe on your favorite podcast app and plan to put your left brain thinking cap on every week. Until next week, stay safe, everybody.