Why we love Fortinet:
Cybersecurity Company → Industry Tailwinds
High valuation by ‘value investing’ standards
Potential loss of market share to competitors
Imagine a service every business requires to avoid losing money, customers, and operational capacity. If most businesses in the United States completely lacked or needed more of this service, it would be the investment opportunity of a lifetime. Luckily for investors, this service is not a fantasy - it is called cybersecurity, and companies like Fortinet Inc (NASDAQ: FTNT) are ready to capitalize on the growing demand for companies to secure their digital systems.
The cybersecurity industry has heavy tailwinds, which makes companies like Fortinet attractive investments based solely on the type of service they provide. For years, experts have warned that U.S. infrastructure like oil pipelines, the electrical grid, and other commercial firms are vulnerable to attack through their digital systems. Recent high-profile hacks, such as those against the Colonial Pipeline and JBS (meat processing) underscore the urgent need for better cybersecurity among U.S. firms. The inevitable rush to insulate infrastructure and other commercial firms against attack will add fuel to the already growing cyber industry.
Cybersecurity is also an attractive investment because of the recurring revenue price structures commonly found in the industry. Once a cybersecurity company has implemented its protective measures for a firm, it collects revenues for the maintenance of that security service. Thus, cybersecurity firms have reliable recurring revenues from old customers in addition to the revenues from new clients in a fast-growing industry.
Within the cybersecurity industry, many public companies are not profitable. Companies pursue rapid growth at the expense of their bottom line. However, Fortinet has defied this trend by remaining profitable for the past five years while consistently growing revenue at 15-20%. Operating income has grown at a compounding rate of ~65%. Net income has fluctuated due to certain non-operating expenses but has still achieved an average compounding growth rate of ~70%. While these growth numbers on the income statement are impressive, it is even more impressive that FTNT has no long-term debt, and is therefore growing in a sustainable fashion through resources generated by its goods and services.
There are a few risks when considering an investment in Fortinet. First, Fortinet’s P/E ratio of 77 is astronomical when considered in a value investing setting. In a major stock market correction, this would be a concern for investors. Secondly, Cybersecurity is a technologically driven industry with many new firms entering the market. It is possible that Fortinet could lose market share to one or more startups that have to provide better protection.
Overall, we at People’s Capital believe Fortinet is a strong investment on a 3-5 year timeline. The cybersecurity industry is set for major expansion in the coming years, and Fortinet is a fundamentally sound company that is well-positioned to take advantage of the trend towards more secure digital systems.
The People’s Capital Team