AI Security And Zero Trust Execution Risks Will Challenge Progress Yet Still Support Long-Term Upside

Catalysts

About Zscaler

Zscaler provides cloud delivered security services that help enterprises protect users, data and applications.

What are the underlying business or industry changes driving this perspective?

• Although demand for AI security is helping AI Security ARR track toward the company’s internal $0.5b fiscal 2026 target, customers may slow adoption of newer modules like AI Guard and AI Red teaming if budgets stay tight, which would limit the step up in subscription revenue and temper operating leverage from this pillar.
• While Zero Trust Everywhere already has more than 450 enterprises and is being pulled into branches and cloud workloads as companies move off legacy firewalls and VPNs, many of Zscaler’s roughly 4,400 enterprise customers are still early in this journey. Any delay in branch refresh or SAP RISE projects could therefore stretch out upsell timing and keep ARR growth closer to the core ZIA/ZPA run rate, affecting both revenue and free cash flow.
• Although the broad Zero Trust and data security platforms help customers consolidate multiple point products, CIO scrutiny on large deals may push buyers to phase deployments more slowly. This could cap near term expansion in data security ARR of about $450m and limit margin gains from higher attach of premium modules.
• Despite the company processing 0.5 trillion transactions daily and over 90 billion AI or ML transactions per month, the need to prioritize speed to market for new AI rich offerings over efficiency, as management has flagged, may keep gross margin near the current ~80% level for longer if infrastructure costs for AI use cases remain high.
• While acquisitions such as Red Canary, Avalor and SPLX broaden agentic SecOps and AI security capabilities, integration risk around products and go to market, together with management’s plan to invest aggressively against a large opportunity, could weigh on operating margin around the guided full year range and create volatility in earnings growth.

Assumptions

This narrative explores a more pessimistic perspective on Zscaler compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts. How have these above catalysts been quantified?

• The bearish analysts are assuming Zscaler's revenue will grow by 19.7% annually over the next 3 years.
• The bearish analysts are not forecasting that Zscaler will become profitable in next 3 years. To represent the Analyst Price Target as a Future PE Valuation we will estimate Zscaler's profit margin will increase from -1.4% to the average US Software industry of 11.9% in 3 years.
• If Zscaler's profit margin were to converge on the industry average, you could expect earnings to reach $576.9 million (and earnings per share of $3.3) by about February 2029, up from $-41.0 million today.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 92.4x on those 2029 earnings, up from -677.4x today. This future PE is greater than the current PE for the US Software industry at 28.7x.
• The bearish analysts expect the number of shares outstanding to grow by 3.07% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 8.6%, as per the Simply Wall St company report.

Risks

What could happen that would invalidate this narrative?

• AI Security is a clear growth focus, but the company is prioritizing speed to market over efficiency for these newer products, and management has indicated this is already influencing the gross margin around 80%. If AI rich offerings keep using more infrastructure without offsetting pricing power, long term gross margins and earnings could come under pressure.
• Zero Trust Everywhere and Zero Trust Branch depend on customers replacing legacy firewalls, VPNs, SD WAN and other branch hardware. CIOs are still working with tight IT budgets and scrutinizing large deals, so slower project rollouts or a pullback in branch and cloud refresh plans could weigh on ARR growth and future revenue.
• The company is leaning heavily into acquisitions such as Red Canary, Avalor and SPLX to build out Agentic SecOps, data fabric and AI security capabilities. Although early integration is described as on track, there remains execution risk around product integration and go to market alignment, which could add cost and limit operating margin improvement and free cash flow if synergies take longer to show up.
• Data Security Everywhere has grown into roughly US$450m of ARR and is pitched as a broad platform that replaces multiple point products. If enterprises continue to mix and match specialist vendors for data security or AI security rather than standardizing on a single platform, Zscaler’s upsell potential across its 8 data modules could be lower than expected, affecting subscription revenue growth and operating leverage.
• Management plans to “invest aggressively” to pursue what it describes as a large market and to extend into areas like agentic operations and AI security. This could keep operating expenses growing faster than some investors expect, so if revenue growth moderates from the current low to mid 20% range while spending stays elevated, operating margin and earnings per share targets may be harder to sustain.

Valuation

How have all the factors above been brought together to estimate a fair value?

• The assumed bearish price target for Zscaler is $238.48, which represents up to two standard deviations below the consensus price target of $315.03. This valuation is based on what can be assumed as the expectations of Zscaler's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
  
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $390.0, and the most bearish reporting a price target of just $215.0.
  
• In order for you to agree with the more bearish analyst cohort, you'd need to believe that by 2029, revenues will be $4.9 billion, earnings will come to $576.9 million, and it would be trading on a PE ratio of 92.4x, assuming you use a discount rate of 8.6%.
  
• Given the current share price of $174.34, the analyst price target of $238.48 is 26.9% higher.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.