Fortinet Earnings: Despite The Challenging Macro, This Sizzles (NASDAQ:FTNT)

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 recent 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.