FTNT is benefiting from a huge increase in cybersecurity spending, which is expected to reach $120 billion this year and grow at a double-digit pace for the foreseeable future. The need for cybersecurity is at an all-time high and that presents a long-term opportunity for companies with the knowledge to combat it.
FTNT has been a strong performer for the past six months, but at 12X forward sales, shares have a lot more room to appreciate.
Strong free cash flow margins of 35%, together with high 20%+ CAGR guidance, make this stock a compelling argument.
FTNT is a provider of network security solutions that are designed to address the problems of an increasingly bandwidth-intensive network environment and a more sophisticated IT threat landscape. Fortinet provides automated network security, but provides exposure to a variety of other markets.
These markets include: user/device security, network security, cloud security, and security operations. FTNT’s primary focus is Network Security.
The company is successfully gaining market share in newly emerging field of SD-WAN solutions services (Network Services). In the first quarter, SD-WAN contributed fourteen percent of total billings as there were 15 deals over $1 million. This compares to only 4 deals worth $1 million in Q1 2020. SD-WAN solutions provides an excellent market opportunity for FTNT, as the space is not saturated.
FTNT provides firewalls, VPNs, and virus protection through its hardware appliances and software subscriptions. The Company also covers newer technologies, including advanced threat detection and endpoint security. Advanced threat detection includes quarantining and studying unknown code to identify previously unknown threats. And endpoint security refers to covering the corporate firewall, as well as all those devices that are remotely bridged to the network.
Fortinet counts the majority of the Fortune 100 as its customers, and it’s seen its large deals steadily increase. Additionally, Fortinet, like many of its midsized peers, sell entry-level products to smaller businesses, but these only represent about a third of its sales.
KenXie, CEOKen Xie founded Systems Integration Solutions, NetScreen, and Fortinet. Xie was previously the CEO of NetScreen, which was acquired by Juniper Networks for $4 billion in 2004.
Turn on the news. What do you hear? Oil pipeline operator Colonial Pipeline announced that it had opted to pay hackers a $4.4 million ransom to regain control of its infrastructure. Major meat supplier JBS learned it, too, had been hacked. And the list goes on. In the World Economic Forum’s most recent ranking of global threats, the four rated most likely to happen deal with climate and armed conflict. But what comes next? Data breaches and cybercrime.
Check Point Software Technologies estimates a weekly average of around 1,000 ransomware attacks alone directed at U.S organizations. That’s the equivalent of an attack every ten minutes. Cybersecurity Ventures currently estimates the global annual figure at around $6 trillion. And estimates are that the market will grow to $10.5 trillion by 2025. Technology market research outfit Gartner suggests the world’s going to spend $150.4 billion this year to sidestep the risk of becoming part of that $10 trillion statistic, up 12.4% from last year’s cybersecurity spending.
How large is the total addressable market opportunity for FTNT? Management estimates approximately $93 million by 2024.
It would appear that the market is supportive of both comprehensive product portfolios and niche specialists. For example, companies like Check Point Software Technologies, offering a suite of solutions to corporate clients, are trading near all-time highs. And so, too, are specialists like FireEye have performed equally well, as well as demand for advanced threat detection and consulting has moderated. This isn’t to say that we don’t believe FireEye won’t be successful in the long run, rather there is less risk associated with a stock like FTNT offering a more diverse array of solutions.
Fortinet offers a more diverse portfolio that appeals to companies large and small, from those looking to take the first steps to improve their network integrity to those with long commitments to security. We expect Fortinet to be a far less volatile way to profit from the rising demand for online security.
Fortinet faces competition as intense rivalry forces industry players to increase their selling and marketing expenses. As indicated in the graphic above, FTNT generates roughly 40% of its revenues from network security appliance sales. The segment has relatively low margins and has the potential to lose market share to cloud-based security service providers.
Financials and Valuation
FTNT’s revenues are driven primarily by its services segment, and roughly 65% of these revenues are recurring.
Fortinet has seen revenue grow by an average of 20% over the past five years. Q1 2021 billings rose 27.4% year over year and we expect revenues to gather some near-term acceleration.
Billings increased driven by solid execution across a broad and integrated product and services. Secure SD-WAN contributed 14% to first quarter billing. Total revenue grew 23% to $710 million with product revenue growing 25%. Looking at the numbers, this is the highest quarterly product revenue growth in the last five years.
FTNT management has provided guidance of 26% operating margins at the midpoint.
Fortinet’s shares have dramatically outperformed its peers over the past six months.
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FTNT generates strong Free Cash Flow and FCF margin is at 29%.
FTNT has a solid history of EPS beats.
In 2020, FTNT spent more than $1 billion on share repurchases. The Company has reduced the number of shares outstanding from 175 million to 166 million. During the Q1 2021 Earnings Call management expressed a clear preference to allocating capital to new growth opportunities.
The Company has a diversified revenue across geographies: Americas (~40%), EMEA (~40%), and APAC (~20%).
Free cash flow for the first quarter came in at $264 million, up $22 million from the first quarter of 2020, despite a $24.5 million year-over-year increase in CapEx spending.
The Company ended the year with total cash and investments of $3.1 billion, an increase of $1.5 billion. The increase includes the proceeds from the Company’s $1 billion investment grade debt issuance during the first quarter.
FTNT received an inaugural strong triple B credit rating and leveraged the strength of its balance sheet as a competitive advantage to support partners and customers as they experienced geo-specific economic challenges.
For 2021E, management expects the following: billings in the range of $3.685 billion to $3.745 billion, which at the midpoint represents growth of approximately 20%. Revenue in the range of $3.080 billion to $3.130 billion, which at the midpoint represents growth of approximately 20%. Total service revenue in the range of $2.020 billion to $2.050 billion, which represents growth of approximately 21% and implies product revenue growth of approximately 17%. – Management Q1 2021 expectations (April 29, 2021).
Fortinet is valued at 12x forward sales, which proves to be an attractive valuation when you consider its strong tailwinds in its sector. FTNT FCFC margins are perhaps one of the highest in the space at nearly 30%. For comparison, CrowdStrike is valued at 38x forward sales. Only, FireEye, which is undergoing a business divestment, is priced at about 10x forward sales when you value ongoing business operations. However, in the case of FireEye, its margins are far below those of FTNT’s.
Source: Seeking Alpha Premium
FTNT Investment Strategy
The Investor Weekly recommends investing in best-of-breed securities, with sound fundamentals, for a three- to five-year time frame. We believe FTNT to be one of these securities.
There is likely to be some consolidation in the cybersecurity sector that could cause some volatility and take a while to play out, but we expect Fortinet to come out on top.
The Investor Weekly took a position in FTNT on June 03, 2020 at $215.
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I am/we are long Fortinet (“FTNT”) either through stock ownership, options, or other derivatives.
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