Ron Sharon

Cybersecurity and Technology Leader

Fortinet (FTNT): Top Cybersecurity Company Offered At A Discount

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MF3d/E+ via Getty Images

Fortinet is a cybersecurity company that was founded in 2000, went public in 2009, and is now the only pure play S&P company in the industry. It doesn’t take much to see that FTNT is a very high quality company, and is best in class as far as pure play cybersecurity companies go. The founder and CEO, Ken Xie, is a serial entrepreneur and an innovator in the field. The growth numbers tell the story of a company likely in its prime.

12-Year CAGR since IPO

Revenue

23.1%

EPS

27.3%

FCF Per Share

22.7%

FTNT’s biggest customers are Exclusive Networks Group and Ingram Micro Inc. Combined they account for about 40% of total revenue, but bigger name accounts include BABA, ADSK, and OTCPK:VWAGY .

The share price has compounded at very high rates since the IPO, but some of this is certainly attributed to the incidental timing of the IPO as it was near the bottom of the 2008 crisis.

dividendchannel

The TAM for cybersecurity was around 165 billion in 2021, and is estimated to grow to 366 billion by 2028. With TTM revenue of around 3 billion, FTNT’s market share is poised to grow with the industry. No company has more than 10% market share, and its not clear who could be the dominant player.

Capital Allocation

FTNT isn’t a young company anymore, but it’s still exclusively a growth company. However as the company grows, capital allocation will take on greater and greater importance. The management team is led by a virtuoso in the cybersecurity industry, but how has capital allocation been so far?

They’ve made over a dozen smaller acquisitions, usually for undisclosed amounts. The largest was $44 million paid for Meru Networks in 2015. A much bigger acquisition could certainly happen but for now there is a clear pattern of smaller buyouts to vertically integrate in the industry.

More recently an emphasis has been placed on reducing share count.

CAGR of Fortinet share price since IPO

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Source

Last year 2 billion dollars were approved for more buybacks till 2023. Most tech companies must reach maturity before they can even begin returning capital via buybacks. The profitability and FCF provide the ability to keep growing organically, acquire multiple businesses, as well as strategically reduce share count. This sums up the unique opportunity that FTNT provides as a stock.

The table below compares the returns on capital:

Company

10-Year Median ROE

10-year median ROIC

TTM EPS

FCF Per Share

FTNT

11.7%

11.7%

3.32

7.5

PANW

-22.2%

-11.5%

-5.27

14.8

OKTA

-81.65%

-50.33%

-4.75

0.80

ZS

-51.7%

-18.4%

-1.93

1.35

CRWD

n/a

n/a

-0.94

1.82

These return measures aren’t designed for money losing companies of course, but the point is that FTNT is profitable while its closest competitors aren’t yet. This isn’t just an arbitrary feature. While the SAAS business model is powerful as far as gross margins go, it’s a rare feat to grow a SAAS type company profitably, while using little debt or dilution. This is where FTNT stands out from the pack.

The ROE also doesn’t work very well with FTNT for two reasons. One is that the net income has been relatively volatile, and the second is that large amounts of deferred revenue push the equity down

Margin Expansion

If profitable growth wasn’t enough, gross and operating margins have expanded over the past decade.

Year

2012

2013

2014

2015

2016

2017

2018

2019

2020

TTM

Gross Margin

72.4%

70.%

70%

71.6%

73.5%

74.2%

75%

76.6%

78%

76.9%

Operating Margin

18.8%

11.7%

7.7%

2.2%

3.7%

7.4%

13%

16.2%

18.9%

19.9%

Source

The next table shows insider ownership, which I consider another important differentiator that FTNT has over its competition. Considering research suggesting that founder led companies tend to outperform, it logically makes sense that you also want the founder to own a larger stake in the business.

Company

Market Cap

Insider Ownership

FTNT

48.35 bil

11.4%

PANW

49.15 bil

1.9%

OKTA

28.35 bil

0.10%

ZS

33.71 bil

1.00%

CRWD

38.42 bil

0.9%

Source

Valuation

Like most high performing tech companies, multiples will almost always trade at a premium. Unless you can time the covid bottom perfectly, you will have to pay up for a capital-light growth company. The share price is a little beaten up from this drawdown, but it may be cheapest available for a while. Compared to other tech growth stocks, FTNT hasn’t taken it on the chin the way others have.

As far as multiples, EV/FCF will be best since most of their competitors aren’t profitable currently.

Company

EV/SALES

EV/FCF

FTNT

14.9

37.1

PANW

10.4

32.8

OKTA

26.6

259.9

CRWD

31.3

93.3

ZS

46.5

180.3

I don’t like using the DCF as the core of my thesis, since it has inherent biases. This is my DCF with admittedly very optimistic assumptions.

dcf model of FTNT

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Source

This puts shares close to fairly valued currently. Tech growth names could still keep declining this year, but I’m not here to make any macro calls at all. FTNT is a premium company with high multiples most of the time, so this could be the closest thing to a discount you could see for some time.

Conclusion

The growth story for this company is clear. FTNT is a hot company in a hot industry. The TAM is increasing and FTNT will definitely take part. They still have market share to gain organically and through M&A. Excess FCF will be used to repurchase shares. The founder and CEO is absolutely world class and owns a large equity stake compared to peers. FTNT is largely a bet on Ken Xie, who has proven to be one of the best CEOs in the world.

Right now may be the closest thing to a discount you will see for a tech company such as this.