Why Fortinet's Investors Are Feeling More Secure

Try to envision a tech world where security isn't a chief concern. Financial documents wouldn't need firewall protection and email accounts would no longer require passwords. Now wake up. In the meantime, companies such as Fortinet , which protects corporate enterprises from hackers and other intruding threats, are in a market with attractive long-term fundamentals.

Granted, Check Point Software's depressing fourth-quarter results suggested the contrary. But Fortinet delivered the goods. While this rivalry was once a classic case of "dog eat dog," that's not so much the scenario today.

Recovering from a dismal third quarter
Saying Fortinet has had some recent challenges would be an understatement. Not only is the company coming off of an uninspiring third quarter which showed declining profitability, but Ken Goldman, Fortinet's CFO, left to assume the same post at Yahoo!.

The uncertainty caused the stock to drop 10% in the trading sessions that followed. Needless to say, Fortinet had plenty to prove in this fourth-quarter report, and the company came through. Fortinet beat both top and bottom line estimates. Revenue surged 25% year over year to more than $151 million, topping consensus of $144 million.

Likewise, profitability was solid, as non-GAAP earnings per share registered at $0.17, up 21% year over year and $0.02 better than Street estimates. Net income of $28.1 million advanced 21% sequentially and grew 26% year over year. All of this suggests that Fortinet is now over this temporary bump in execution and the company is kicking major tail.

Looking for the kill shot
Now onsider Check Point's recent results. Although Check Point is considered the best in its class, it's no longer looking that way -- at least not according to the top line, where the company just posted 3% revenue growth. Making matters worse, this marked the seventh consecutive quarter where Check Point posted deteriorating year-over-year sales.

This means that Check Point is losing meaningful market share not only to Fortinet, but also Cisco and possibly smaller rivals such as Palo Alto Networks. Remarkably, it doesn't appear as it Check Point cares.

For instance, not only did the company spend less this quarter on sales and marketing, but it seems to care more about preserving capital and less about preserving market share. I could be wrong, but that's exactly what a meager 8.8% increase in research and development spending suggests.

By contrast, not only did Fortinet report a 20% increase in sales and marketing, but Fortinet also increased R&D expenses by 25%. Remarkably, and perhaps even more impressive, is despite this uptick in expenses, Fortinet still managed strong profits, showing that it never lost its focus on the bottom line.

Granted, non-GAAP gross margin shed 40 basis points year over year. But it arrived much better than estimates. Likewise, that operating income surged 28% means that management is maximizing the dollars earned from each new customer. While Check Point can boast about its impressive balance sheet, it won't be too long before Fortinet can say the same.

Then again, Check Point still deserves the benefit of the doubt. There's no question that it will eventually straighten things out. In the meantime, its lack of aggression should concern investors -- especially since Fortinet is in full-throttle mode and looking for the kill.

Moving forward, what does guidance say?
Security services industry has become a huge market. Plus, with cloud platforms not yet fully understood, companies are feeling insecure about sending their big data into cyberspace. This means that the market is about to expand. And Fortinet guided as if it expects to seize a significant chunk of it.

The company expects full-year revenue to arrive in the range of $625 million to $635 million -- ahead of Street forecasts of $618.9 million. This includes first-quarter revenue projections of $141 million, which would represent 20% growth year over year. Following the strong guidance, shares of Fortinet surged 25%.

Fortinet also received a standing ovation from Nomura Securities, which raised its price target on the stock from $24 to $26 per share. Conversely, Check Point disappointed analysts with a revenue range of $355 million to $387 million. Although Check Point is expecting very little growth, the rest of the competition has no plans on ceding the market to Fortinet.

Margin pressure from a company such as Dell may eventually become an issue. After Dell's $1.2 billion acquisition of enterprise security giant SonicWall, the company is looking for ways to grow its top line. To that end, it may seek to undercut Fortinet. Fortinet would then be forced to either lower prices or cut R&D investments. Either scenario may prove unfavorable.

In the meantime, there's plenty to love with this company and the stock. Fortinet's long-term revenue growth has shown no meaningful signs of slowing down and neither has cash flow. Despite the recent surge in the stock, a case can be made that these shares are yet undervalued -- given the expansion potential of this market. Having said that, a P/E of 57 doesn't imply cheap, either. But that's never stopped Amazon.

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The article Why Fortinet's Investors Are Feeling More Secure originally appeared on Fool.com.

Fool contributor Richard Saintvilus has no position in any stocks mentioned. The Motley Fool recommends Amazon.com, Check Point Software Technologies, and Cisco Systems. The Motley Fool owns shares of Amazon.com and Check Point Software Technologies. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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