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Fortinet Investment Thesis Summary

Volatile markets can result in some of the most seasoned investors questioning their investment decisions. During times of increased market turbulence it is always important to highlight why investment decisions were made as these will ultimately guide long term returns.

Therefore, we have summarised some of the most compelling reasons behind the holding of Fortinet in the Global Equity Fund.

Fortinet (FTNT:US). Founded in 2000 by brothers Ken Xie and Michael Xie, Fortinet is an American multinational corporation that develops and sells cybersecurity solutions, including but not limited to physical products such as firewalls, plus software and services such as anti-virus protection, intrusion prevention systems and endpoint security components.

Importance of Cybersecurity

The cybersecurity industry presents a compelling investment opportunity with the industry having significant tailwinds on the back of the growing demand for security services brought about by the increased dependence and use of electronic devices.

This is illustrated by the fact that in the space of only six years it is estimated that the cybersecurity industry will grow by nearly US$100 billion (see graph below).

The increased need for cybersecurity is made evident by the fact that it is estimated that 100 billion security events are analysed per day and 10 million network intrusion events are resisted per minute.

In addition, the importance and priority of cybersecurity is reflected by the fact that spending on security software is the least likely to be decreased of all information technology spending (see graph below).

The increased demand for cybersecurity bodes well for Fortinet as the often indispensable nature of cybersecurity provides them with significant pricing power.

Revenue Analysis

Fortinet operates in the following segments (see graph below for revenue breakdown) -

  • Network Security;

  • Infrastructure Security;

  • Cloud Security;

  • Endpoint Protection;

  • Internet of Things; and

  • Operational Technology.

An analysis of Fortinet's revenue over the past decade provides an indication that Fortinet has managed to satisfy the growing demand for cybersecurity with revenue more than quintupling since 2009.

The industry is complicated and dynamic, with many participants servicing a range of niches. Fortinet is one of the three largest players in the network security software market. As illustrated in the graph below, Fortinet has managed to steadily increase its market share, with compound revenue growth in excess of 20% per annum over the last decade.

Another positive aspect for Fortinet is the geographic diversification of their revenue as reflected by the graph below, with a relatively even split of revenue across the three major regions (Americas; Europe, Middle East and Africa; and Asia Pacific). This diversification of revenue allows for them to be less susceptible to the political and economic climate of one country or region.

Focus and Capital Allocation

Unlike most technology businesses, Fortinet has managed to maintain a healthy balance between maintaining high revenue growth while continuing to focus on profitability. This is largely due to its engineering-centric founders, who focus on delivering industry leading products instead of buying growth with excessive marketing.

This is illustrated by the below graph with Fortinet having nearly triple the number of patents that its closet competitor FireEye.

In addition, free cash flow margins have exceeded 30% for the last four years (see graph below) while growing revenues at 20% per annum, creating significant value for shareholders.

The excess free cash flows have been used to make small acquisitions and a couple of significant share buybacks. Unlike most technology companies who use buybacks to offset share based compensation, Fortinet has used buybacks to add significant value for shareholders.

During 2020, the company bought back shares valued at over US$1 billion during the first quarter to take advantage of the sharp market downturn. The returns on capital illustrate management's impressive capital allocation abilities (see graph below).

The above article has highlighted some of the most pertinent reasons behind the holding of Fortinet to the Global Equity Fund that include the positive metrics relating to its revenue, the growing importance of cybersecurity as well as their prudent capital allocation.


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