EUR 850.00 For Business Accounts Only

Morningstar | Fortinet reported a Solid 3Q, but a Lofty Valuation Weighs on Results; Raising FVE to $70. See Updated Analyst Note from 01 Nov 2018

Fortinet benefited from another robust quarter, reporting revenue of $453.9 million and non-GAAP EPS of $0.49 for its third quarter of fiscal 2018, well ahead of our expectations. Thus, we have raised our full-year revenue and earnings targets, leading to a fair value increase to $70 per share from $63 previously. We believe we have not been giving Fortinet enough credit for long-term margin expansion. While we model robust growth for Fortinet and have increased our fair value, we have been iterating for the past few quarters that the firm’s lofty valuation has left no room for error, as shares traded down modestly after the third-quarter results. We would like this name on a pullback, but see shares as fairly valued today. We continue to believe Fortinet and many of its cyber security peers lack economic moats.

The firm grew its top-line 21% year over year and GAAP operating margins expanded to 13.8% from 9% one year prior, giving us confidence that the firm can continue to achieve robust operating leverage. Those 13.8% margins represent the highest margins in the past few years and we model additional expansion ahead, as we now model 31% midcycle operating margins.

We think the firm’s top line continues to benefit from the firm’s Security Fabric platform, which allows clients to protect against a number of vectors of attack. As enterprises grapple with increasing data, multi-cloud environments, and Internet of things devices, customers need a platform that can protect against all these new points of entry. The 21% revenue growth represents revenue acceleration from a year ago, but we note that Fortinet has been susceptible to product cycles. While we believe the shift from one-time product-based revenue to software and subscription-based revenue will somewhat mitigate this, Fortinet’s CEO noted on the third-quarter call we are probably midway through a longer product cycle. Thus, a slowdown, while not imminent, will likely surface in the next couple years.

As a reminder, Fortinet’s bread and butter is still the small-to-medium size business market. While the firm has admirably landed a number of notable enterprise customers, SMBs are more susceptible to churn in a market downturn which we have not experienced for several years. Thus, we believe revenue will inevitably slow and it is hard for us to get excited about the firm’s valuation at this juncture.