EUR 850.00 For Business Accounts Only

Morningstar | Fortified by Its Enterprise Presence and Subscription Offerings; Raising Fortinet FVE to $87

Fortinet's growing presence in the enterprise space is buttressed by its leadership position in the SMB-focused unified threat management appliance market. Its product entrenchment and consolidated security platform, offering a variety of subscriptions, have cemented customer switching costs, leading us to increase our economic moat rating to narrow from none. We are supporters of Fortinet selling higher-end products alongside its subscriptions to combat hybrid-cloud security concerns, and we have increased our fair value estimate to $87 per share from $75. With Fortinet in 3-star territory, we recommend that investors hold this security.

We believe the vast creation of data and the dispersed nature of network traffic, due to hybrid and multi-cloud-based environments and software-as-a-service applications, create a continually increasing number of threats. Attacks are becoming more masqueraded and serpentine, which drives up the complications associated with cybersecurity management and threat prevention. Compounded by a dearth of cybersecurity talent, we think that consolidated security platforms, like Fortinet's Security Fabric, will remain in high demand, as customers prefer to add capabilities via subscriptions over managing disparate software and hardware vendors.

The company has a build-versus-buy mentality, with a penchant for making custom processors. While we believe this strategy has helped establish its name within the perimeters of localized networks, we expect Fortinet to supplement its engineering prowess with inorganic growth in areas like cloud-based security, machine learning, and automated threat responses. In our view, these high-growth areas can help drive new product growth on top of a considerable base of durable services and support income.

We model Fortinet generating a 14% five-year revenue CAGR, which is driven by services and subscriptions outpacing product revenue. As a result of selling a larger percentage of higher-margin services and subscriptions, we model gross margins expanding to about 78% in 2023 compared with 75% in 2018. Through gross margin expansion and revenue outpacing operating expenditures, we model operating margins expanding into the high teens by 2023 versus 13% in 2018. We expect research and development to remain around 13%-14% of revenue, while sales and marketing expenses should decrease toward 40% of revenue by 2023 versus 43% in 2018.

We believe Fortinet and its major competitors will benefit from security teams looking to consolidate the number of cybersecurity vendors they employ. We expect Fortinet to continue adding capabilities to its Security Fabric platform, which helps extract additional revenue per customer while diversifying the company away from its reliance on selling security appliances.