Wednesday, January 6, 2010

Morgan Stanley Global Tech Day 1.06.10

Fortinet – A Pure Play on the Fastest Growing Security Market
(FTNT, $18, O/I)
Adam Holt / Keith Weiss / Munish Jain
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For analyst certification and other important disclosures,
refer to the Disclosure Section, located at the end of this

We are initiating on FTNT with an Overweight rating and $22 price target. FTNT is a leader and net share gainer in the fastest growing market in security, Unified Threat Mgmt. (UTM). As companies look to consolidate security technology and lower costs in an increasingly complex threat landscape, firms are migrating to UTM solutions, sustaining mid-teens market growth. We think investors can win two ways with this stock: 1) near-term, cons. ests. hold upside - as IT spending improves, FTNT gains share, and margins inflect upward, and 2) longer-term, the strategic shift to UTM solutions and FTNT's leadership position should sustain mid-to-high teens organic growth, 2X our group avg. Our $22 PT, up 20%, assumes a 24x EV/FCF on our CY11 est., in line with the CY10 multiples of high growth comps.

Powerful Growth Drivers – Our due diligence suggests that FTNT's combination of purpose built chips and operating system, broad distribution, and industry leading value proposition uniquely position the co. to continue gaining share in the UTM market. Additionally, our work points to three other growth levers: 1) a nascent firewall appliance refresh cycle giving opportunity for displacements, 2) FTNT's release of new high-end products - which should drive ASPs higher, and 3) FTNT has barely touched the Federal vertical, which is one of the most robust security markets and could add 3-5 points to organic growth alone. Net, our 10% forward 2 yr. rev. CAGR is likely conservative.

Model is Conservative – At current levels, FTNT investors have the opportunity to buy the stock as the market is improving and margins are inflecting, but these elements are not yet reflected in consensus. In Q3, margins expanded 9% points YoY, yet we model flat margins in CY10. Rev. growth accelerated to +21% YoY in Q3, yet we model only 10% growth in CY10, reflecting no IT spending improvement-while our checks suggest that demand has improved since the IPO. Each 5 points of rev. growth above our CY10 est. yields $0.03-0.04 in CY10 EPS to our est. of $0.27.

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