Chances are good that you heard about the Equifax data breach that came to light in September 2017. Hackers were able to steal crucial information such as social security numbers, addresses, and even driver’s license information of 143 million Americans, highlighting the need for strict cybersecurity measures.
Not surprisingly, corporate organizations and governments are shoring up their defenses to avoid such instances in the future. This is one of the reasons why Fortinet‘s (NASDAQ: FTNT) growth has hit a higher gear.
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But there’s more to Fortinet than just a short-term catalyst. Let’s take a look at a couple of metrics that will clearly establish why Fortinet is built for long-term growth.
Subscriptions are driving deferred revenue and margins
Fortinet’s deferred revenue rose an impressive 27% year over year during the quarter that ended in March, outpacing its actual revenue growth of 17%. The company is currently sitting on nearly $1.4 billion in deferred revenue, which is close to its trailing 12-month revenue of $1.55 billion.
Deferred revenue is the amount collected by a company for services that will be provided at a later date. This line item sits as a liability on the balance sheet until the services are actually delivered, which is when it is recognized as revenue on the income statement. The concept of deferred revenue is usually found in businesses selling a subscription, just like Fortinet does.
An increase in the deferred revenue is a positive indicator of a company’s health, proving that it is sucessfully selling its subscription plans and is locking in customers for the long run.
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In fact, Fortinet’s subscription revenue rose a healthy 25% year over year last quarter as compared to the 6% growth in product sales, which is a positive sign. It is currently getting around 64% of its total revenue by selling subscriptions, with the remaining coming from product-related sales.
So the company still has a lot of room to increase subscription sales and reduce reliance on product-driven revenue. As such, its margins will improve as it is believed that retaining subscribers is three to five times more cost-effective than acquiring new customers for a product.
This is because a company will find it easier to sell upgrades to existing subscribers instead of spending money on acquiring new clients. Not surprisingly, Fortinet enjoys nearly 86% gross margin in the subscription business as compared to just 60% in the product business, and the growing contribution of the subscription business is gradually steering its gross margin higher.
|
Period |
Q1 2017 |
Q2 2017 |
Q3 2017 |
Q4 2017 |
Q1 2018 |
|---|---|---|---|---|---|
|
Subscriptions as a percent of total revenue |
60% |
61% |
63% |
61% |
64% |
|
Gross margin percent |
74.60% |
73.70% |
75% |
75.60% |
76.70% |
Consensus estimates project that Fortinet’s earnings will grow at a CAGR (compound annual growth rate) of nearly 24% over the next five years. And, it seems to be on track to hit this target, since the subscription business will keep getting better on the back of the new features that Fortinet is deploying.
Pulling the right strings
Artificial intelligence (AI) is the new buzzword in cybersecurity. ESG Research estimates that just 12% of enterprise organizations are currently deploying AI-enabled security analytics extensively in their operations, while 27% are doing so on a limited basis. But more organizations want to use AI to improve incident detection time, accelerate responses to cybersecurity threats, or get a bird’s-eye view of the cybersecurity situation in their organization.
Fortinet doesn’t want to miss this bus, so it recently added machine learning capabilities to the FortiWeb web application firewall (WAF). This addition brings advanced behavioral threat detection to the WAF. In simpler words, Fortinet claims that WAF will now be able to thwart attacks automatically on web-based applications, which can include anything from Gmail to internet banking, with 100% accuracy.
Additions such as these should help Fortinet get more business out of its customers, who are already spending more money on its services. Last quarter, Fortinet saw a 20% spike in $50,000-plus deals, while the number of $1 million-plus deals increased 21%. This is another big reason behind the company’s improving margin profile and adjusted net income, which had shot up nearly 84% last quarter to $57 million.
Given the improvements that the company has been making to its cybersecurity platform and further growth of the subscription business, Fortinet should be able to keep growing its earnings and revenue at a fast pace. As such, investors looking for a long-term cybersecurity play should take a closer look at this stock given that it trades at just 41 times forward earnings, which is significantly lower than the industry average of 110 times.
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Harsh Chauhan has no position in any of the stocks mentioned. The Motley Fool recommends Fortinet. The Motley Fool has a disclosure policy.
