Fortinet, Inc.

Moat: 4/5

Understandability: 2/5

Balance Sheet Health: 5/5

Fortinet, Inc. is a global cybersecurity company providing a broad suite of solutions including firewalls, endpoint protection, and cloud security.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview

Fortinet’s core business revolves around securing networks and data for organizations of all sizes. The company operates in the highly competitive and ever-evolving cybersecurity sector. Here’s a more detailed breakdown:

Revenues Distribution: Fortinet’s revenue is primarily categorized into product revenue and services revenue. The split between the two has been fairly consistent in the last few years, with product revenue being slightly more than services revenue. Product revenue includes sales of the company’s various network security platforms and related hardware. Service revenue is derived from a number of sources including, subscription-based security services, support contracts, and security updates. They have a global reach, and derive their revenue from Americas, EMEA and APAC regions. Americas account for approximately 40% of total revenue.

Industry Trends: The cybersecurity market is experiencing strong growth, driven by increasing threats and attacks, a hybrid work environment requiring better security posture, and the continued move to the cloud. This growth is creating a larger addressable market for cybersecurity solutions and has created a fast growing demand for security-as-a-service.

Margins: Fortinet has had consistently high gross margins with an average of ~78% for the last two years. Their operating margins have been steadily improving, with operating margin exceeding 20% in 2023. Both show the company’s strong pricing power and efficiency of operations.

Competitive Landscape: The cybersecurity landscape is fragmented, with many players across various sub-sectors. The larger players include Palo Alto Networks, Crowdstrike, and Check Point, and several others with strong capabilities in specific areas. Fortinet differentiates itself by offering a broad portfolio of products and a focus on developing integrated solutions. They emphasize the high-performance and integrated nature of their security platform. They have a “platform approach” which tries to create an end to end security solution. Competitors are starting to adopt a similar approach.

What Makes Fortinet Different?: Fortinet’s approach is defined by the following:

Broad Portfolio: They provide a wide array of security solutions across network, endpoint, and cloud.
Integrated Solutions: Their products are designed to work together and provide a unified security platform. Their strategy is to integrate all offerings into a single platform, providing centralized management and analytics.
Custom Developed Technology: Unlike some competitors who rely solely on third-party chips, Fortinet produces its own chips and other software solutions. This enables greater control over their products, and it gives them more control over the supply chain.
Focus on Performance: The company places strong emphasis on high-performance security solutions.

Latest Concerns: In their most recent quarterly report, Fortinet mentioned the following:

Macroeconomic conditions, such as a possible economic downturn or recession, and possible increases of inflation or regulation, increasing or decreasing interest rates, volatility in the global markets or international political tensions are among the uncertainties, which may adversely impact the business
Our operating results are likely to fluctuate significantly and unpredictably.
We are vulnerable to supply chain constraints, including ongoing component and other shortages, rising freight costs, and increased lead-time for components and finished goods and any supply changes.
Our billings, revenue, and cash flow growth may slow or may not continue, and our operating margins may decline.

Moat Assessment: 4 / 5

Based on my analysis, I assign Fortinet a moat rating of 4 out of 5, indicating a strong, yet not invulnerable, competitive advantage, here is why:

Network Effects: While not a pure network effects play, Fortinet’s integrated platform creates a somewhat “network-like” effect. As more customers adopt their broader suite of products, this drives more data into their ecosystem, which provides better security for all their customers. This makes their solution more valuable and harder for their customers to leave.
Intangible Assets: Fortinet’s strong brand and reputation for performance and stability provide an edge. The high costs for research and development in the industry is also a barrier of entry. The brand, along with their proprietary technology also enables them to charge a premium relative to competitors.
Switching costs: As their products get more deeply integrated into client systems and processes, it becomes a larger hassle for the client to switch out systems and vendors, because of the need for full data integration, and the training of new staff. So clients tend to stick with what they have.

Risks to the Moat:

There are a few legitimate risks that are impacting the company’s moat:

Technology Disruption: The cybersecurity industry is characterized by rapid technological change. New innovations from competitors, or the emergence of new forms of attacks, could render Fortinet’s current solutions less effective. The change to AI-driven security is a big disruptive force.
Competition: As the cybersecurity industry becomes more crowded and more competitive, pricing pressure or loss of market share could arise. Competitors are starting to adopt platform approaches, making competition more intense for them. They can no longer offer a unique advantage.
Execution: A more complex product portfolio could impede the company’s efficiency, and if they are unable to integrate, or if they prioritize too many unrelated lines of business at once, this may make the whole company less valuable and hinder efficiency.

Understandability: 2 / 5

I assign an understandability rating of 2 out of 5, primarily because:

Technical Complexity: The core technology behind cybersecurity is complex and ever-changing. Understanding the underlying concepts of Fortinet’s products, while not necessary for valuation, adds a layer of difficulty for people who do not have a deep technical knowledge on cybersecurity.
Product Diversity: While the overall strategy is easy to grasp, Fortinet offers a huge array of products, services and security solutions, which can be overwhelming to keep track of. A lot of effort would be required for a non-expert to be familiar with what they all do, and how they all work with each other.

Balance Sheet Health: 5 / 5

Fortinet has an excellent balance sheet and is in a 5 out of 5 position.

Strong Cash Position: They have a very high cash balance, with over $2.3B at the end of March, 2023.
Minimal Debt: They have minimal debt, which implies that most of their investments are done with their own money. This enables a lot of flexibility and stability in their finances.
Positive Free Cash Flow: They have had strongly positive free cash flow, providing a lot of operating flexibility and options.

The Essays of Warren Buffett: Lessons for Corporate America | Moat: NA / 5 | Understandability: 1 / 5 | Balance Sheet Health: NA / 5

The Essays of Warren Buffett: Lessons for Corporate America is a collection of Warren Buffett’s letters to the shareholders of Berkshire Hathaway. The collection is focused on his principles for running a business, his investing philosophy, and the importance of accounting information.

Business Overview

The book is essentially a compendium of business and investment wisdom as interpreted and applied by Warren Buffett. It covers topics that touch upon:

Corporate Governance: Buffett’s core belief is in the owner-related business principles where he treats shareholders as owner-partners and managers as their stewards. He promotes transparency and a preference for those that think like owners when making business decisions.
Corporate Finance and Investing: Buffett espouses that he focuses on fundamentals, patience, and strong judgement for investing. He strongly rejects the efficient market theory and values companies based on their intrinsic value rather than a P/E multiple.
Common Stock: He explains what it means to be a long-term investor, and promotes the idea that he is a co-venturer with other shareholders-who are, in essence, his partners. He recommends investing in companies he trusts and admires, and the belief that stocks should be viewed as business units and the stock market is a means of moving capital from one business to another.
Mergers and Acquisitions: He discusses many value-destruction scenarios that occur with mergers and acquisitions, citing his ‘double-barreled approach’ that involves only acquiring businesses with great management, a clear understanding of the business, and at an extremely reasonable price. He doesn’t like issuing stock for acquisitions.
Accounting and Taxation: He explains how to spot accounting shennanigans by recognizing the difference between accounting and economic goodwill, and using look-through earnings to account for earnings of their investee companies. He also discusses the tax advantages and disadvantages of certain investment approaches.

Moat Assessment: NA/ 5

This book is not about any particular business, therefore, there is no economic moat that needs to be evaluated.

Understandability: 1 / 5

I’d assign this a rating of 1, because the core messages of the book are mostly simple and easily understood without a deep background in investing, finance, and accounting. Buffett mostly tries to explain things in the most simple and easy-to-understand manner as possible. This makes it one of the most accessible books in the industry.

Balance Sheet Health: NA / 5

This book is not about a particular business. Thus, there is no need to assess any balance sheets.

Common Stocks and Uncommon Profits and Other Writings | Moat: NA / 5 | Understandability: 3 / 5 | Balance Sheet Health: NA / 5

“Common Stocks and Uncommon Profits” by Philip Fisher offers insights into identifying and profiting from growth stocks, primarily through qualitative analysis and understanding of a company’s business and management.

Business Overview

Fisher’s book delves into a qualitative approach to investing, contrasting with the more quantitatively driven methods of other investors. Key components of his philosophy include:

The Scuttlebutt Approach: Gathering information about a company through various sources like competitors, customers, suppliers, and ex-employees to form a thorough and informed perspective beyond purely financial data. He recommends identifying the qualities of a business and management before looking into the financial details, instead of the opposite approach.
Emphasis on Growth: Fisher’s primary focus was on identifying companies with long-term, sustainable growth prospects, by understanding the potential of its market, the abilities of its management, and the effectiveness of their R&D efforts. He stresses that growth should have a long runway.
The Fifteen Points: He outlines fifteen specific points an investor should consider to find a good company, emphasizing the importance of growth potential, management, research, product, and financial stability.
Patience and Long-Term Holding: Fisher advocates for patient investing, emphasizing that the best results come from identifying excellent growth companies and holding onto them for many years.
Limitations of Market Timing: He does not recommend trying to time the market, focusing instead on quality and the prospects of a company.

Moat Assessment: NA / 5

This book is not about a particular company, therefore there isn’t a moat that can be assessed.

Understandability: 3 / 5

I’d assign the book a rating of 3 out of 5 in understanding, as there is a lot of high level advice and principles, such as the 15 points. But it can be a bit challenging to grasp what he really wants you to do. There are a few anecdotes which help, but it is not particularly easy to apply.

Balance Sheet Health: NA / 5

This book is not about any particular business. Thus, there is no need to assess any balance sheets.

The Little Book That Builds Wealth | Moat: NA / 5 | Understandability: 2 / 5 | Balance Sheet Health: NA / 5

“The Little Book That Builds Wealth” by Pat Dorsey offers a guide to building wealth by selecting companies with “economic moats,” which are sustainable competitive advantages.

Business Overview:

The book provides a framework to find businesses that are likely to be profitable in the future, based on their existing competitive advantages. Key themes in the book include:

Economic Moats: The book focuses on the concept of economic moats, the structural competitive advantages that allow companies to sustain their profits over time. He outlines three basic types of economic moats: Intangible Assets, Switching Costs, Network Effects, and Cost Advantages.
Valuation: The book highlights the importance of buying stocks at a discount to their intrinsic value, and suggests multiple valuation tools like Price to Sales, Price to Book, Price to Earnings, etc. for this purpose.
Emphasis on Long-Term Investing: Dorsey advocates for a patient investment strategy, urging investors to focus on companies with sustainable competitive advantages and hold them for long periods to reap the benefits of compounding growth.
Importance of Management: He says that management only has a limited amount of influence on the long-term sustainability of a business. What matters more are the competitive advantages of a business that are difficult for others to replicate.

Moat Assessment: NA / 5

This book doesn’t discuss any one particular company. So there is no moat to be evaluated.

Understandability: 2 / 5

I’d rate the understandability as 2 out of 5, primarily due to the fact that it delves into the concepts of economic moats, valuation techniques, and competitive dynamics, which requires some background on finance and business analysis.

Balance Sheet Health: NA / 5

Since the book doesn’t relate to any particular business, there is no need to assess a balance sheet.