Internet security breaches have dominated the headlines recently, as Target (TGT) and Barclays (BCS) are only among the latest big-name corporate casualties of the faceless cyberhackers who mine databases for sensitive user information.
The niche opportunity for “cyberwar” stocks is a large one. The Department of Defense has estimated that hackers can wreak some truly staggering economic damage, stealing more than $250 billion a year in intellectual property. And tech research firm Gartner has estimated that businesses spent $60 billion on information security hardware and software in 2012, and that number could rise to nearly $90 billion by 2016.
In this volatile trading and economic environment, I look for companies that have a strong presence in a growing market. This segment clearly fits the bill. Cybersecurity firms saw their stocks race ahead alongside a buoyant market last year. The sector is also rife with takeover deals and acquisition chatter, as was seen recently when Fireeye (FEYE) jumped 39% in a single day on word that they would buy Mandiant, a small computer forensics firm.
While there’s no shortage of companies in this space that have heart-palpitating revenue growth, many have no attendant earnings to speak of. These stocks have skyrocketed because their hypergrowth may be of interest to older firms looking for a “bolt on” buy to help sales or technology suites.
However, I think it’s important to look past these high-flying stocks and take a closer look at companies that have real earnings and cash flow. I want to be able to feel secure (no pun intended!) that money is being generated to be reinvested in the business, and eventually returned to shareholders. I also look for an indication that they’ve weathered some macro and company-specific concerns recently, which would tell me they have resilience to hold up well in this market.
Today’s new recommendation succeeds on all of these counts, and its growing market share gives it an added advantage.
Let’s take a look at it now.
Fortinet (FTNT) is a $3.3 billion market cap company specializing in network security. It focuses specifically on unified threat management, which means the typical firewall has evolved into an all-in-one product that detects and prevents intrusions. The company offers a number of application control and firewall software offerings, but its flagship device is FortiGate, a network security platform that can work for anyone from small offices and retailers to large enterprises and data centers.
Travel management firm Globetrotter is a client of Fortinet that has benefitted from this award-winning technology. To increase efficiency and remain competitive, Globetrotter deployed a high-performance IT network infrastructure across Switzerland connecting all local offices in the country. As added protection for their data center, the company installed FortiGate to apply gateway security for Internet access. EMC’s (EMC) subsidiary VMWare has also been a user of Fortinet’s products.
The stock hit a low point last fall, dipping down to the mid-teens when CFO Ahmed Rubaie left the company after only a short time, citing personal reasons. Wall Street never likes to see senior executives leave if there’s no real turnaround in the works, and investors get jittery that the current business course may be interrupted with new management in place. However, shares rebounded nicely and have since stabilized as Andrew DelMatto was named CFO.
FTNT’s most recent results also indicate a good rebound from a tough first half last year. Last month, the company posted earnings of 15 cents a share, beating estimates by a penny, on a 17% increase in revenues to $177 million, which easily outpaced the $166 million the Street had anticipated.
Management’s outlook speaks to continued strong results. Current quarterly forecasts are for revenues of $155-$159 million and earnings of 12 cents a share, which are in line with analysts’ estimates of $155 million and 12 cents per share.
Billings and margins were above the company’s guided range, and that speaks well to cost control and steady demand. Management also said it has been able to take market share from security peers, which would also indicate that the all-in-one solution has been gaining traction, presumably among cost-conscious businesses.
On a conference call, the company noted that billings growth was strong across all geographies, especially in the Americas (up 24%). That growth occurred across all verticals, including the service provider and government sales at a combined 37% of the top line.
Many of FTNT’s security peers have actually seen slowdowns in these segments, which further hints that the company is gaining market share. In fact, management called out a specific large deal at a telecom carrier, where it displaced McAfee and Juniper (JNPR).
The shares have risen since the report, and may look a bit pricey at first glance. FTNT trades at roughly 36X 2014 estimated EPS, adjusted for a 13% net cash position. But if margins continue to improve amid the demand that seems to be steady, then the 60 cents a share that the Street looks for in 2015 may prove conservative (Remember that investors typically look at least one year ahead for earnings as a metric).
Firing on all cylinders, I see FTNT earning as much as 75 cents per share in 2015. Using the midpoint of the 4-8X sales multiple that peers trade at (typically used as a yardstick for “takeout” value), we get a target range of $29-$30. The company also has $161 million remaining under its buyback program, which could help boost shares in the near term.