It was reported that Singapore lost >SGD500m to cybercrime in 2023. Imagine, our small country of a few million people, losing that much. What would that number be in China, US and Europe? Based on population sizes, it could be 300x more ((China’s 1.3bn + US’ 300m + Europe’s 500m) / Singapore’s 6m = 300). That’s USD150bn!
The company we are discussing today is one of the cybersecurity play listed in the US. Recently, the firm published some good quarterly investment materials and we shall be highlighting many of the key slides here starting the one on Total Addressable Market. The company estimates that its TAM is currently USD125bn but will grow to USD200bn by 2027.
Cybersecurity is big business!
Next, let’s take a look at the simple financials. It is also worth noting that the company has generated high teens growth to sometimes 30% YoY growth for more than 10 years.
Simple financials (Dec 2024 estimate, USD)
- Sales: 5.5bn
- EBITDA: 1.7bn, EBIT 1.5bn
- Net income: 1.2bn, FCF: 1.7bn
- Debt: -1.0bn (net cash), Mkt Cap 38.7bn
Ratios
- ROE >100%, ROIC 70%
- EV/EBITDA 21.7x (Dec 24), PER 29.9x (Dec 24)
- Past margins: OPM 15-20%
- FCF yield 4-5% (4.4% based on no.s here)
As one the leaders in the cybersecurity space, the company has also enjoyed stable high margins, extraordinarily high ROICs and good Free Cashflow. Due to its recent earnings weakness, shared price collapsed, presenting an opportunity for us to buy. That said, it is still not cheap with PER at close to 30x based on consensus no.s although it looks better with c.5% FCF yield.
1. Fundamentals
Cybersecurity is a megatrend with hackers being way more sophisticated vs 20 years ago and companies and individuals needing more software and solutions to protect themselves. The company has projected market growth to be c.12% but its own revenue has grown close to 20% over the last 15 years.
The company has implemented its own rule of 40 stating that revenue growth and operating margins should exceed 40 in any given year. As we can see, it has comfortably achieved this over the last 5 years. Management is also focused on Free Cashflow and it started generating billion dollar FCF in 2021 and looks like it should hit USD2bn this year.
The company we are discussing today is Fortinet (FTNT US) and we have the following investment thesis:
Fortinet is a leader in network security and is a key beneficiary of the ever-growing cybersecurity megatrend. It is a differentiated player in its space with unique technology which has allowed the firm to build a strong and diversified customer base across geographies. It also boasts higher margins and stronger FCF growth vs its peers.
Fortinet is a network security specialist with 70% of revenue coming from its security network business. The firm is the only cybersecurity vendor with its own SPU or security processing unit with application specific design multi-core processor that has supported generations of secure infrastructure with every iteration. Its main product FortiGate Firewall has 20 years of track record and helped the firm expanded its business portfolio to encompass more recurring revenue and value added services such as SASE*.
Today, Fortinet has an another 20% of revenue coming for universal SASE and 10% from security operations. While its business is entirely related to network security, Fortinet has diversified its business across customer types, geographies and industries. The following charts provide the breakdowns showing how its businesses are evenly split.
*SASE or Secured Access Service Edge, extends networking and security capabilities allowing work-from-anywhere and remote workers, to take advantage of firewall as a service, secure web gateway and zero-trust network access and a medley of threat detection functions.
Positives
Continuing increase in penetration of secured networks: Networking used to be simple installations. We only needed LAN cables but with the advent of cloud and increased cybersecurity threats, network has become increasing complicated and needed to be secured. Starting from a few years ago, secured network installation picked up globally and penetration stands at 40% of all networks today. This is expected to grow to more than 52% in 2030 i.e. more than half of all networks are secured networks. Fortinet stands to benefit from this trend as the leading player in the field.
High recurring gross profits: The nature of the cybersecurity business calls for monitoring, service and support. As such, c.65% of Fortinet’s gross profits comes from service and such high recurring gross profits look set to grow as we can see from the chart below:
As its installed base grows, cost is spread across to a bigger revenue pie and use cases are learnt and reapplied to solve similar problems with other clients. The strengthens Fortinet’s moat and widen the knowledge gap between the company and its smaller competitors. We shall revisit this point later.
Strong shareholder returns via share buybacks: Fortinet’s business is highly FCF generative and it has spent a significant sum in share buyback over the years, repurchasing 214m shares (c.20% of outstanding shares) for USD5.8bn. Fortinet’s current buyback until Jan 2024 will be accretive at current valuation and providing further downside support for share price.
Risks
High growth markets are naturally highly competitive and cybersecurity is no different. Fortinet needs to compete with its bigger and more prominent peer - Palo Alto Networks alongside a slew of US and global competitors. It is unclear if the firm can maintain its high margins indefinitely.
At the same time, behemoths like Microsoft, Google and Apple would also be keen to enter this space given its importance to their core business. These are trillion dollar companies that have all the resources to compete. Fortinent’s own slide below illustrates the risk we are discussing well.
Mitigating factor: Fortinet has USD5bn of revenue in its space, second only to Palo Alto (as shown above) and should be strong enough to compete against the peers listed above. On the other hand, if Google or Microsoft is looking for something to acquire in cybersecurity, then Fortinet will also be interesting as a target. So as long as management continues to execute well, earnings and share price should do okay.
Management
Fortinet is founded in 2000 by two brothers: Ken Xie (60) and Michael Xie (54) and together they still own c.20% of the company. Ken is Chairman and CEO while Michael is President and CTO. Needless to say, Fortinet will not be here today without them and while the management team is professional and strong, Ken and Michael will be instrumental to Forinet’s continuing growth.
2. Technicals
The following chart shows how Fortinet has traded over the last 5 years. Recall that Mar 2020 was an important point in time for many stocks as it reflected maximum fear at the height of the pandemic but looking at Fortinet’s stock price, it is probably not relevant and we see a stronger support near today’s share price of USD52.
The rest of the post is on 8percentpa.substack.com
Huat Ah!
This post does not constitute investment advice and should not be deemed to be an offer to buy or sell or a solicitation of an offer to buy or sell any securities or other financial instruments.
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