These ‘Three Horsemen’ of cybersecurity most likely to weather slowing demand, Morgan Stanley says
By Wallace Witkowski
Meanwhile, Zscaler, SentinelOne, Tenable get downgraded
Peak cybersecurity demand has passed and investors need to get selective about their stock picks in the sector, as it remains to be seen whether a slowdown in spending is because businesses are gun-shy with a possible recession looming or if they just loaded up early on new services.
Morgan Stanley analyst Hamza Fodderwala said the sector is “bending but not breaking” going into 2023. Given recent hacks, information security will be the item least likely to be cut on a company’s capital expenditures budget. Even so, as companies seek to weatherize themselves against a possible recession, the pressure to keep expenses low is evident in the waves of layoffs that are hitting the tech sector.
“The slowdown in security is just starting,” Fodderwala said, and macroeconomic conditions and year-ago comparisons will “remain difficult” through 2023. While stock valuations reflect this, Fodderwala said it will take estimates take longer to hit bottom.
Read: Salesforce ‘in the penalty box,’ while Workday sidestepping headwinds, analyst says of cloud software space
“We think estimates for the group may take longer to bottom as we’re comingdown from peak growth levels,” he said. “As such, we expect security demandto be much less of a ‘rising tide’ and are being far more selective in 2023.”
Fodderwala downgraded Zscaler Inc. (ZS), SentinelOne Inc. (S) and Tenable Holdings Ltd. (TENB), all from overweight to equal weight. The analyst recommended leaning into his “Three Horsemen” of cybersecurity, with Palo Alto Networks Inc. (PANW) his top pick, followed by Fortinet Inc. (FTNT) and CrowdStrike Holdings Inc. (CRWD).
“The key debate from here is whether moderating security demand is a function of broader spend optimization efforts from enterprises preparing for slowing macro OR if there was material pulled-forward demand and we’re now due for an extended digestion period/growth slowdown like we saw during the last down-cycle of 2015-16,” he said. “While some amount of digestion is likely to occur, we still lean towards the former view.”
Over the past 12 months, the ETFMG Prime Cyber Security ETF (HACK) has fallen 24% and the First Trust Nasdaq Cybersecurity ETF (CIBR) is down 21%. Following a tough November that started badly, the iShares Expanded Tech-Software Sector ETF (IGV) has fallen 25% over the past 12 months, while the Global X Cloud Computing ETF (CLOU) has dropped 29%, the First Trust Cloud Computing ETF (SKYY) has fallen 37% and the WisdomTree Cloud Computing Fund (WCLD) has dropped 42%. Meanwhile, the S&P 500 is down 14% and the Nasdaq is off 25%.
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