Fortinet Still Growing Strong

Fortinet (NASDAQ: FTNT) crushed the market’s (and its own) estimates and its full year guidance was above current estimates. The company appears to have hit a sweet spot in the market place with its mix of affordability, performance and sophistication. In summary, Fortinet is now expanding out of its core SMB strength and into larger enterprises where the increasing performance of its solutions are making it attractively priced. In a cautious large enterprise spending market this is the right time for Fortinet to step up.

Fortinet’s Equity Research

The stock has been weak recently with various commentators and analysts forecasting a weaker outlook going forward. I always think it is a good idea to rationally look at the reasons why they might think this rather than to dismiss these fears with pejorative disdain. Before I go into that, here is a summary of sequential revenue growth plus the mid-point of guidance for the next quarter.

My suspicion is that some analysts were piecing together a jigsaw from what other companies are saying and then producing a picture where the pieces kind of fit but the image is wrong.
For example some of the pieces include

• Palo Alto Networks (NYSE: PANW) gave a strong earnings report but it also cited aggressive pricing competition in the quarter and PANW is primarily US focused
• Check Point Software (NASDAQ: CHKP) recently gave a set of numbers that I found disappointing and its product and license revenue growth has now turned negative
• Fortinet  disappointed last time around and reported some relative underperformance in China (in fact this spilled over into this quarter too)

Putting these things together suggests a cautious spending environment where PANW is winning share from incumbents, pricing is becoming an issue, and product growth is hard to come by. Conclusion?  Fortinet will find it tough.

Well it didn’t quite work out like that and here is my best guess why.

Fortinet Market Share

Going back to what Check Point said it seems that it is in the middle of establishing a new appliance platform and its new products are offering far better performance than the old ones did. However this seems to have spurred customers to buy the cheaper options and this retain the same performance but at a cheaper price. Moreover it is hard not to conclude that CHKP is losing out on wins with PANW being aggressive in the market place. The stock is great value on a cash flow basis and a forward PE of 13.5x, but its prospects continue to be downgraded and product sales growth is now negative.

As for Palo Alto it is making a splash in the market and using its IPO money it appears to be investing in sales and marketing in order to grab share from incumbent firewall players like Cisco Systems (NASDAQ: CSCO) and Juniper Networks. The takeaway from Fortinet’s conference call is that Cisco and Juniper and falling behind in terms of performance but they are still able to try and sell security as part of an overall solution provided it is bundled with things like switches and routers etc.


In other words it is not a core strength of these companies. Indeed CHKP said a similar thing and –if anything- I get the impression that Cisco and Juniper are falling behind in security. Cisco is releasing new products but its growth in security has slowed for the last three quarters on a sequential basis.
According to this article Cisco is minded to make an acquisition in security and looked at Palo Alto before its IPO. If true, it's questionable whether it would go back now the evaluation is higher. In addition one of Palo Alto's key strengths is its sales and marketing operations and this is not necessarily an area where Cisco is weak. I think Fortinet is a more likely destination for Cisco's takeover cash.

In summary, I think CHKP’s product refresh may have placed it outside the sweet spot of what corporations want to spend on (according to Gartner it is known for sophisticated but relatively expensive solutions) and JNPR and CSCO are falling behind. PANW is growing strongly but FTNT believe that it has superior performance in technical based ‘bake-offs’. Indeed it cited deals where it replaced PANW and this is not a great sign for a young fast growing company.

Meanwhile FTNT’s solutions are increasing being adopted by large institutions and it has won a number of contracts against CSCO, JNPR, CHKP and PANW.

Is Fortinet a Stock to Buy?

I think this company is a genuine takeover target, but is good value in its own right. The full year guidance of EPS of 60-61c may make it look expensive but recall that deferred revenues just grew at over 23% and the forecast for free cash flow is $180-190m putting it on a forward FCF/EV yield of 6.6% as I write. That is far too cheap for a company growing earnings in the mid-teens.
It’s in a sweet spot right now and I would expect that to continue for a while. The question is how long before a cash rich incumbent looks at the company?