Fortinet (FTNT) Thriving On Growth Initiatives, Risks Persist

We issued an updated research report on Fortinet Inc. (NASDAQ:FTNT) on Aug 19.

Fortinet is a provider of network security appliances and Unified Threat Management network security solutions to enterprises, service providers and government entities worldwide. Its solutions are designed to integrate multiple levels of security protection, including firewall, virtual private networking, anti-virus, intrusion prevention, Web filtering, anti-spam and wide area network acceleration.

In late July, the company reported better-than-expected results for second-quarter 2016, wherein both the top line and the bottom line outpaced the respective Zacks Consensus Estimate.

Although Fortinet’s adjusted earnings per share were flat at year-ago levels, revenues jumped around 30%, aided primarily by its strength in the network security space. A large number of deal wins and customer additions during the quarter further drove top-line growth.

Buoyed by the strong top-line performance in the second quarter, Fortinet raised its full-year revenue and billing expectations. The company now anticipates revenues in the range of $1.274 billion to $1.284 billion (previous projection: $1.262–$1.272 billion), representing a year-over-year improvement of 27%. Billings are now projected in the range of $1.530 billion to $1.540 billion, up from the earlier guidance of $1.520–$1.530 billion.

We believe the company’s strategy of focusing on selling subscription-based services will facilitate more stable revenues and margin expansion. Subscription-based service is a high gross margin business (approximately 80%) compared to the hardware-centric model.

Furthermore, Fortinet has made strategic acquisitions to expedite growth. Last year, the company acquired Meru Networks, a company engaged in the development and marketing of a virtualized wireless LAN solution. The acquisition is a positive for Fortinet as it will help to strengthen the latter’s cloud capabilities and expand the solutions portfolio, thereby allowing it to tap into the $5 billion worldwide enterprise Wi-Fi market with integrated and intelligent secure wireless solutions.

Despite of these growth initiatives, we are somewhat skeptical about Fortinet’s near-term performance due to changing customer spending behaviors. During the second quarter, various players in the cyber security space noticed that companies have been breaking their cybersecurity investment plans into phases and implementing the same over longer periods of time, instead of making a single large investment.

Therefore, we are concerned that 2016 spending may fall to 2014 levels. Notably, cybersecurity spending by companies had skyrocketed last year due to a series of high-profile security breaches.

Intense competition from key network security players such as Cisco Systems Inc. (NASDAQ:CSCO) , Check Point Software (NASDAQ:CHKP) , Juniper Networks (NYSE:JNPR) and Palo Alto Networks is another major concern.

Currently, Fortinet carries a Zacks Rank #3 (Hold).