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Fortinet Inc (NASDAQ: FTNT) shares are rising Wednesday morning after the company reported mixed fourth-quarter results and issued strong guidance. Several analysts also raised price targets on the stock following the company's quarterly results.

Fortinet said product revenue was up 43% year-over-year, while service revenue grew 27%. Billings jumped 32% compared to the prior year's quarter.

"Our market share gains are being driven by Fortinet's integrated and single platform approach to cybersecurity combined with FortiASIC technology, which lowers the management costs and the total cost of ownership for organizations," said Ken Xie, founder, chairman and CEO of Fortinet.

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Outlook: Fortinet expects first-quarter revenue to be between $1.18 billion and $1.22 billion versus estimates of $1.18 billion. First-quarter adjusted earnings are expected to be in a range of 27 cents to 29 cents per share versus estimates of 27 cents per share.

Fortinet sees full-year 2023 revenue between $5.37 billion and $5.43 billion versus estimates of $5.36 billion. The company sees full-year adjusted earnings in a range of $1.39 to $1.41 per share versus estimates of $1.39 per share. 

Analyst Assessment: 

One firm also downgraded the stock after shares charged higher on earnings: Keybanc analyst Michael Turits downgraded Fortinet from Overweight to Sector Weight.

FTNT Price Action: Fortinet has a 52-week high of $71.52 and a 52-week low of $42.61.

Fortinet shares are up 12.1% at $60.26 Wednesday morning, according to Benzinga Pro.

Photo: vicky gharat from Pixabay.

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© 2023 Benzinga.com. Benzinga does not provide investment advice. All rights reserved.

© 2023 Benzinga.com. Benzinga does not provide investment advice. All rights reserved.

Governance & Risk Management , Operational Technology (OT) , SASE

Fortinet has blunted the impact of the economic downturn by helping customers consolidate their security footprint and add protection in areas such as OT, Wi-Fi and SD-WAN.

See Also: Live Webinar | Navigating the Difficulties of Patching OT

The Silicon Valley-based platform security vendor says its proprietary ASIC chip allows the company to take market share from rivals as it delivers superior performance in fields such as SD-WAN at a fraction the cost. IDC found Fortinet leads the market with 48% of firewall units shipped, which CEO Ken Xie says offers economies of scale and creates cost barriers for any rival looking to develop a chip of its own (see: Ken Xie on Why Fortinet Is Leaning Into SD-WAN, OT Security).

"We continue to gain market share in the cybersecurity industry," Xie tells investors Tuesday. "Fortinet has a huge security computing power advantage, allowing FortiOS to integrate more security functions and applications than our competitors with much better performance and much lower energy consumption."

Chief Financial Officer Keith Jensen tells investors Fortinet will deliver a $29 million cost savings over the next half-decade to a U.S. retailer with more than 500 locations. Fortinet replaced the multiple consoles the retailer previously used with a single pane of glass and took out the competitor's basic firewalls in favor of FortiGates that delivered URL filtering, Wi-Fi security and edge router replacement, Jensen says.

'We Do Have a Huge Advantage Compared to Other Competitors'

Customers increasingly want protection for more than just traditional corporate networks, and Xie says Fortinet's ability to secure both conventional IT settings as well as operational technology environments has gained traction in the market. Xie said in May Fortinet's OT business will be bigger than its SD-WAN practice due to the elevated threat environment and increased interest from manufacturing customers (see: Fortinet CEO Ken Xie: OT Business Will Be Bigger Than SD-WAN).

"In the long term, we do have a huge advantage compared to other competitors because of the investment we made in the product and the hardware with the ASIC, which gives us a huge advantage around total cost of ownership," Xie says. "We're committed to keep gaining market share in the space."

While protecting profit margins and lowering the total cost of ownership have driven interest from large enterprises, Xie says small and midsized businesses have turned to Fortinet due to the need for greater ransomware protection. Fortinet's SMB growth has been particularly strong in regions such as Europe, according to Xie.

Xie says enterprises also have turned to Fortinet to drive convergence between their security and networking teams, and many large organizations are making moves to bring their security operations center and network operations center closer together.

"That's where we see a lot of the big enterprise customers," Xie says. "They definitely want to add additional protection for their infrastructure while having a better total cost of ownership at the same time and leveraging a single, integrated platform to offer better security and networking together."

From a backlog perspective, Xie says the logjam has shifted in latest quarters from network firewalls to more traditional networking equipment such as switches and Wi-Fi routers. Xie expects supply chain issues to dissipate over the course of 2023, but Fortinet recognizes that not all the backlog will convert into revenue due to cancellation rates in the high single digits around networking equipment.

In August, networking equipment accounted for 50% of Fortinet's backlog due to continued challenges sourcing raw materials for switches and access points, while the company's FortiGate firewalls accounted for 40% of the backlog (see: Fortinet Looks to Address Rising Costs With Price Increases).

Sales Surge in North America, Europe

Fortinet's revenue of $1.28 billion in the quarter ended Dec. 31 fell short of Seeking Alpha's sales estimate of $1.3 billion. Meanwhile, the company's non-GAAP earnings of $0.44 per share crushed Seeking Alpha's non-GAAP estimate of $0.39 per share.

For the full year, Fortinet's revenue surged to $4.42 billion, up 32.2% from $3.34 billion the year prior. Net income jumped to $857.3 million, or $1.06 per diluted share, up 41.3% from $606.8 million, or $0.73 per diluted share, in 2021. On a non-GAAP basis, net income skyrocketed to $961.6 million, or $1.19 per diluted share, up 44.4$ from $666 million, or $0.80 per diluted share, in 2021.The company's stock is up $6.96 - 12.94% - to $60.74 per share in after-hours trading Tuesday. That's the highest Fortinet's stock has traded since Aug. 3.

The Americas accounted for 40.6% of Fortinet's revenue in the fourth quarter, while Europe, the Middle East and Africa, or EMEA, delivered 39.8% of revenue and Asia-Pacific, or APAC, was responsible for the remaining 19.6% of revenue.

For the quarter ending March 31, Fortinet expects non-GAAP net income of $0.27 to $0.29 per share on revenue of between $1.18 billion and $1.22 billion. Analysts had been expecting non-GAAP net income of $0.28 per share on sales of $1.18 billion, according to Seeking Alpha.

Investment Thesis

Fortinet, Inc. (NASDAQ:FTNT) is a U.S.-based cybersecurity company founded by Xie Jing back in 2000. The company has been one of the best compounders in the past decade, with the stock up over 1,000% during the period. The share price has also been holding up well despite the broad market selloff.

Cybersecurity has a massive TAM (total addressable market) and continues to benefit from secular tailwinds. It is one of the most resilient industries that capture non-discretional spending. The company is also expanding its TAM by entering other verticals, which should open up more growth opportunities moving forward. Some investors are skeptical about the company's prospects, as it generates a large portion of revenue from on-premise products, but the segment continues to grow rapidly despite the shift to cloud security. This is reflected in its latest fourth quarter earnings reported yesterday with upbeat product growth and profitability. The current valuation also isn't too expensive on a historical basis, especially when considering the growth it is showing. Therefore I rate Fortinet, Inc. as a buy.

Huge Market Opportunity

Cybersecurity is a massive and fast-growing market. According to Grand View Research, the TAM for the industry is $222.66 billion in 2023 and is forecasted to grow to $500.7 billion in 2030, representing a CAGR (compounded annual growth rate) of 12.3%. Fortinet estimates its own TAM to be $153 billion in 2023, and it should grow at a CAGR of 10% to $199 billion in 2026. While network security often seemed to be overlooked due to the shift to cloud, it actually accounts for $22.5 billion of the TAM. although it is growing at a slower rate. The company's expansion into new markets like cloud security and zero trust also added nearly $40 billion in TAM, and these segments are also growing much faster. Fortinet's current penetration rate is only around 2.4% despite being such a large company.

The industry is growing quickly due to digital transformation and IoT (internet of things). The penetration rate of the internet and cloud has increased significantly in the past few years which also increased the number of cyberattacks. This vastly increased the demand for more sophisticated cybersecurity solutions as the cost of cyberattacks is huge, especially for big firms. While cloud security benefits from workloads shifting to the cloud, network security is also relevant as many companies are adopting a hybrid approach. Companies still need firewalls and the company dominates in this space. The industry is also seeing a consolidation in vendors as customers want to reduce complexity. This benefits larger vendors like Fortinet as it has a broad product portfolio that addresses different areas.

Keith Jensen, CFO, on vendor consolidation:

There's been an explosion of devices that must be connected to the cloud, data center and edge compute. As a result, the infrastructure has expanded to support secure connectivity via distributed firewalls, it is no longer feasible to overlay security on top of networking in the data center. They must be deployed as a converged solution. Firewalls need to work seamlessly with networking and security applications across the company's entire infrastructure. Fortinet is leading the convergence trend with a wide range of technologies, including network firewalls, Secure SD-WAN, 5G and OT security, all embedded in our single operating system delivered as hardware, software, cloud and as a service.

Q4 Earnings

Fortinet just reported Q4 earnings, and I think the results are very strong considering the macro environment, especially product revenue and the bottom line. The company reported revenue of $1.28 billion, up 33.1% YoY (year-over-year) compared to $963.6 million. The growth is mainly driven by product revenue, which increased 42.5% from $378.9 million to $540.1 million, now accounting for 42.2% of total revenue. During the year, it added over 23,000 new customers for its firewall products. Service revenue grew 27.1% YoY from $584.7 million to $742.9 million, driven by the increase in security subscriptions. Billings for the quarter was $1.72 billion, up 31.6% YoY. Gross profit was $985.7 million compared to $735.3 million with the gross margin flat YoY.

Ken Xie, CEO, on FY22 results:

For the full-year, revenue growth accelerated to 33%. We continue to gain market share in the service security industry with customers increasingly recognizing how Fortinet integrate and a single platform approach to security delivers along total cost of ownership and a greater return on investment than competing solutions.

The bottom line is extremely impressive as the company continues to show strong operating leverage. Despite revenue up over 33%, operating expenses only increased by 20.7% to $627.9 million. This is mostly contributed by S&M (sales and marketing) expenses which grew 24% YoY from $367.7 million to $455.9 million. The discipline in operation spending resulted in operating income increasing over 66.5% YoY from $214.9 million to $357.8 million. Operating margins also improved significantly from 28.5% to 32.5%. EPS for the quarter was $0.40 compared to $0.24, or a 67% increase YoY. It guided revenue for FY23 to be $5.37 billion to $5.43 billion vs $5.35B consensus, representing a solid growth of 22% at the midpoint. The company ended the quarter with only $990 million in debt and $1.68 billion in cash, with provide ample financial flexibility for investments or further share repurchases.

Investors Takeaway

Fortinet, Inc.'s Q4 earnings once again demonstrated why it is one of the best cybersecurity companies in the world. Despite investors' pessimistic view of the product segment, Fortinet still managed to grow product revenue by a whopping 42.5% and added over 6,200 new logos during the quarter. Its strong reputation also helps minimize the S&M spending needed, which resulted in an exponential increase in operating income and EPS.

Considering the huge TAM and its low penetration rate, I believe Fortinet, Inc. can continue to put up consistent growth over the long run, not to mention its opportunities in newer and emerging segments. The current valuation is also not really expensive by historical standards. Fortinet is trading at a fwd price-to-FCF ratio of 23.92x which I believe is very fair, considering its strong growth rates. This is slightly lower than its 5-year historical average of 24.17x. As Fortinet, Inc. continues to scale, the ratio should go down pretty quickly, given the strong operating leverage it has. Therefore, I rate Fortinet, Inc. as a buy.

Investment Thesis

Fortinet (NASDAQ:FTNT) has a less-than-straightforward story. Its business makes the bulk of its revenues from its Product segment. Something that the Street has generally been skeptical of.

But what Fortinet has excelled in, is in delivering high ROI to its customers, through its low cost-for-performance hardware. Consequently, this has allowed Fortinet to print free cash flow.

Indeed, this quarter we saw Fortinet's free cash flow jump 48% y/y. Reminding investors that there's much to like here, so let's get to it.

Fortinet's Near-Term Prospects

Fortinet continues to push forward with its Service segment. Even though the Service segment ever-so-slightly decelerated sequentially from 28% y/y CAGR to 27% y/y CAGR, these figures are quite compelling.

Particularly given that Microsoft's Azure (MSFT) and Amazon's AWS (AMZN) have both had their earnings results and the figures show that cloud enterprise spending is coming down.

However, the big theme for 2023, I suspect, will be around AI. Being a cybersecurity vendor for AI platforms could be a meaningful tailwind for cybersecurity companies.

That being said, the one aspect that has held back Fortinet in the eyes of investors has been the fact that the majority of its revenues come from its Product business. But this may be less bad than it sounds. Here's why.

Given the industry trend towards ''renting'' software services, investors have generally been skeptical of Fortinet's long-term prospects. Given that point of view, Fortinet used their earnings call to highlight that:

[...] a latest Forrester report highlighted that customers deploying Fortinet Secure SD-WAN solutions achieved a 300% return on investment over three years with a payback period of only eight months.

In sum, the story isn't over for Fortinet. Now, let's dig into its financials.

Revenue Growth Rates Are Fair

Fortinet's guidance for the year ahead isn't all that impressive. But what it does show is that there's ''at least'' 22% top line, if we assume that management is lowballing estimates, to leave room to positively impress investors over the coming quarters.

What's more, given that its billings for Q1 2023 are at 26% y/y and higher than the revenue growth rate guidance for Q1 reinforces the overall image that Fortinet's pipeline of future revenues to be ''recognized'' is healthy.

What's more, Fortinet once again reiterated that it believes it can continue to grow its operations to $8 billion in revenues by 2025. This would imply that investors getting involved today would be getting the ''reassurance'' that Fortinet can put out a 22% CAGR over the next two years.

What's more, given that Fortinet has been unwavering in its outlook for some time now, combined with its near-term guidance being compelling, certainly gives credence to its multi-year outlook.

Next, we'll turn our focus to what's arguably the best reason to own Fortinet.

Fortinet's Bull Case Laid Out

Remember 2020? A period when it was ''uncool'' to be profitable? Throughout that period, Fortinet had one of the weakest performances amongst its cybersecurity peers.

Nevertheless, Fortinet continued to plow forward and lay down the work then, to literally ooze free cash flow now.

Accordingly, Fortinet's guidance for 2025 points to somewhere in the ballpark of $3 billion of free cash flow. For a cybersecurity business that's priced at approximately 15x 2-years forward free cash flows, this is really an attractive valuation.

Given the value of its shares, Fortinet has steadily and consistently repurchased its own shares. But here comes the most shocking aspect! Check out the red arrow below.

This is a rare breed of tech companies where repurchasing shares after stock-based compensation actually brings down the total number of shares outstanding.

That being said, it should be noted that looking ahead to 2023, the total number of shares is estimated to trickle higher by approximately 1%, reversing some of the progress of 2022.

The Bottom Line

The message coming out of Fortinet this quarter is about setting the record straight.

What customers actually want in this environment is savings. The time when enterprises were willing to spend beyond the budget to be safe online may be taking a breather after 2020-2021 saw a very strong pull forward in demand.

In sum, paying around 15x Fortinet's 2025 free cash flows is a compelling investment.