Markus Moxham
Research

Fortinet: the market is pricing nine quarters of deceleration as a trend, not a transition

FTNTNASDAQ

Buy at $82.22. A structurally profitable compounder de-rated on a segment shift the market is reading as decay.

Thesis
Fortinet has generated ROIC above its cost of capital every year since 2017, and by more than ten points since 2019, with margins and returns in the top decile of its industry and ten profitable years out of ten. The stock has de-rated since its 2024 peak, tracking a broader sector move and nine consecutive quarters of decelerating service revenue growth. My reading is that the deceleration reflects the mix shifting from hardware toward subscription rather than demand weakening. Product revenue is 32% and growing slowly while security subscriptions are 39% and services gross profit is rising rapidly, which is what a hardware-led vendor transitioning to recurring revenue looks like. The reverse DCF implies 19.61% sustained growth, a rate Fortinet has consistently exceeded, and the customer base is unusually defensible with 80% of the Fortune 100 and 72% of the Global 2000 already contracted.
Key assumption
That decelerating service growth is a mix effect from the subscription transition, not eroding demand. If subscription revenue growth continues falling while product revenue also stalls, the transition thesis is wrong and the de-rating is correct.
What would prove me wrong
A tenth and eleventh consecutive quarter of decelerating service revenue growth. Security subscription revenue, currently 39% of the total, failing to grow faster than product revenue. Renewal or retention weakness within the Fortune 100 base. Tariff-driven enterprise spending cuts materializing in EMEA, which is 40% of revenue.
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  • Founded in 2000, develops and sells security products including firewalls, endpoint security and intrusion detection systems.
  • Launched FortiAI in 2020, threat-detection program using AI
  • No large controversies or leaks, only smaller ones.
  • 80% of Fortune 100 companies are customers, while 72% of Global 2000 companies. Ranked #7 in Forbes most trusted companies in 2024.
  • Technologies: FortiOS (operating system, does not replace Windows), FortiASIC (chips that improve performance of Forti systems), FortiCloud (cloud infrastructure to manage Fortinet systems), FortiAI.
  • Fortinet is the best security ecosystem for medium to large enterprises due to its effectiveness and price, while Palo Alto is more costly but industry leading.
  • Pricing is subscription based (for software).
  • Hardware manufacturing is outsourced. Supply chain management is very important therefore.
  • Operate data centers.
  • Analysts fairly bearish (AI and professional).
  • Product segment profit is slightly increasing, while services gross profit is increasing rapidly. Same story for revenue.
  • Financial strength (6): high cash-to-debt vs industry, average vs industry. Very poor equity to asset and debt to equity vs industry rankings. Interest coverage is good however, and bankruptcy is unlikely (confirmed by Altman Z-score). Very strong debt to EBITDA vs history and good vs industry. ROIC > WACC, significantly.
  • Growth (10): excellent growth rates vs industry and good vs history. FCF growth rate average, and future estimates are average-below average, but still strong considering the size of the company.
  • Momentum (4): average RSIs, weak price momentum (price peaked in 2024 and declined, broader industry trend).
  • Liquidity ratio: very poor ratios vs history, below average vs industry.
  • Dividend and buy back: excellent buyback ratio vs industry and history. Good shareholder yield %.
  • Profitability (10): excellent margins vs industry (top 90%), excellent vs history. ROE is insane. ROIC is also excellent, every profitability ratio excellent vs industry and history (top 90%). 10 years of profitability in last 10, 8 moat score, 8 tariff resilience.
  • Value (10): average vs industry ratios, and good to excellent vs history ratios. Very poor P/S, P/B ratios vs industry. However, software industry so P/B misleads.
  • Good earnings yield vs industry, good FCF yield, and excellent forward rate of return.
  • Revenue growth is steep, while net income and EBITDA trend is consistently increasing at the same rate, no outliers.
  • Cash > debt, and cash is increasing significantly. Company only took on debt in 2021, and levels are healthy around $900M.
  • Operating cash flow increasing rapidly, in addition to free cash flow and net income, while stock based compensation is steady.
  • Positive ROIC - WACC since 2017. Above 10% difference since 2019.
  • Shares outstanding are bought back in some years significantly and others slight dilution occurs. Dilution in 2024, first time since 2019.
  • Total stockholders equity was negative in 2022 and 2023, and positive pre-pandemic and in 2024.
  • Current assets > LT assets (software business). PPE $1.3B and intangible $350M.
  • 39% revenue from security subscriptions, 32% product, 29% technical support.
  • 40% EMEA, 30% US. 19% APAC.
  • Fairly low executive compensation for the size of the company. Still led by founders. Directors with experience.
  • EPS growth exponential. FCF, EBITDA same.
  • 96 GF score.
  • 19.61% reverse DCF growth rate (EPS). Fairly valued assuming current growth rates. Predictability rank of 5 from GF.
  • Service revenue growth rates are the main concern with growth decelerating for the ninth consecutive quarter. Also macroeconomic risks with tariffs (as companies will shift investments).

Backs a position in the record: FTNT, open. +91.2% against +10.7% for the S&P 500. See the position →