Fortinet Earnings: Deceleration in Appliance Sales Mars Result; Valuation Down to $60 From $68

We are lowering our fair value estimate for wide-moat Fortinet FTNT to $60 from $68 after the firm reported weaker-than-expected financial results and guidance. Similar to last quarter, Fortinet saw a deceleration in billings, a forward-looking indicator, as macro headwinds continued to affect demand for Fortinet’s appliances. While the financial results were below our prior estimates, we don’t agree with the market’s knee-jerk reaction to Fortinet’s earnings, with shares down almost 20% afterhours. While the poor near-term outlook is the main driver behind our fair value revision, we’d be remiss not to note the massive opportunity ahead of Fortinet as a platform vendor in an increasingly consolidating security space. Our Fortinet thesis is underpinned by our understanding that the firm’s breadth and quality of solutions will allow it to deliver shareholder value in the long term. Following the afterhours selloff, we view Fortinet as undervalued relative to our updated fair value.

Fortinet’s sales for the third quarter clocked in at $1.335 billion, $29 million below our $1.364 billion estimate and toward the lower end of management’s guidance range provided last quarter. Much like last quarter, the stand-out figure was billings which grew a tepid 6% year over year to $1.491 billion, well below management’s guidance of $1.590 billion. For some context, year-over-year billings growth was 33% a year ago and 18% last quarter. This deceleration was primarily due to a decrease in firewall demand as larger customers slashed their spending on Fortinet’s products.

On the profitability front, Fortinet’s adjusted operating margins came in at 27.8% for the quarter, contracting 50 basis points year over year and ahead of management’s prior midpoint guidance of 25%. Driving this profitability was an ongoing emphasis on operating discipline during a time of macro tightness with investors keeping a keen eye on profitability.