Fortinet: A Pricey Stock with Room to Grow

Fortinet (Nasdaq: FTNT  ) has been very good to its investors since going public 14 months ago. The stock is up 124%, including a 112% gain in the last six months -- and a couple of top-notch earnings reports along the way.

This week, Fortinet jumped more than 16% on Wednesday after reporting 32% year-over-year sales growth and 69% higher earnings. Even better, the order book grew more quickly than the billed revenue, laying a solid foundation for the coming quarter's sales.

What makes you so special?
I had a unique chance to pick the brains of CEO Ken Xie and CFO Ken Goldman (the Ken & Ken Show, in Goldman's own words) to get a better understanding of what sets this security specialist apart from a host of would-be competitors.

In one singular strength, Fortinet designs some of its own custom chips to handle network traffic and filter or flag potential threats. The company delivers a high-performance security system that even megabandwidth handlers Cisco Systems (Nasdaq: CSCO  ) and Juniper Networks (Nasdaq: JNPR  ) find hard to match.

"We are No. 1 in the Unified Threat Management (UTM) space," said Goldman. Even so, the company's overarching goal is to keep stealing share from other players in that particular market. In the world Fortinet envisions, there is no room for security hardware from Cisco, Check Point Software (Nasdaq: CHKP  ) , or SonicWALL. According to Goldman, Fortinet's new product sales are growing by 40%, while the overall market is expanding by a much slower clip "in the low teens." In other words, the company's share-stealing tactics appear to be working.

Growth drivers
Telecom firms are some of the best customers for Fortinet's type of security, since their massive bandwidth flows need a security scrubbing that's both thorough and quick. In particular, everyone from AT&T (NYSE: T  ) to Vodafone (Nasdaq: VOD  ) to Qwest Communications (NYSE: Q  ) is selling high-security service packages all over the world today, and they often use Fortinet's systems to deliver on their promises. The service providers treat this cloud-based opportunity as something of a growth driver, leaving little room for experimentation or sudden architecture changes. Thus, the incumbent UTM leader -- Fortinet, in this case -- grows stronger.

The company has been the subject of buyout speculation in recent months, spurred on by a rash of security and networking deals large and small. Fortinet has a decade-long operating history, and the Ken & Ken duo come with sterling pedigrees from other networking exploits. Fortinet's not some fly by-night microcap, hoping to get lucky and snag a rich sugar-daddy buyer after just a couple of quarters of actual results.

One size won't fit all
That said, the stock trades at a lofty 40 times trailing earnings and about 29 times free cash flows. It's an unlikely buyout target at the moment, and perhaps a little too rich for most investors' blood. Goldman says that free cash flows are important to the way Fortinet is managed, and he's proud to report that the company generated an even $100 million in free cash for 2010. There's more work to do there before the stock starts to look cheap.

If Fortinet doesn't float your boat with a valuation like that, just add the stock to your Foolish watchlist and wait for a better entry point. I'm not ready to commit real money to this stock today, but Fortinet sure looks like it's worth some attention.

Juniper Networks is a Motley Fool Big Short short-sale pick. Vodafone Group is a Motley Fool Inside Value recommendation. Check Point Software Technologies is a Motley Fool Rule Breakers recommendation. The Fool has created a bull call spread position on Cisco Systems. Motley Fool Alpha has opened a short position on Juniper Networks. Motley Fool Alpha owns shares of Cisco Systems. Try any of our Foolish newsletter services free for 30 days.

Fool contributor Anders Bylund holds no position in any of the companies discussed here. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. You can check out Anders' holdings and a concise bio if you like, and The Motley Fool is investors writing for investors.


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