This has been a feast-or-famine sort of quarter of tech investors, and Check Point Software Technologies Ltd.'s (Nasdaq:CHKP) feeble quarterly results certainly had investors wondering what sort of quarter Fortinet Inc. (Nasdaq:FTNT) was going to report. Apparently they needn't have worried, as this fast-growing security hardware specialist came through. While Fortinet's valuation doesn't scream bargain, aggressive investors could still find opportunity here.

Discount Brokers Comparison: Your one-stop shop for finding the perfect broker for your investments.

Coming Back Strong

Suffice it to say, Fortinet freaked out investors with a pretty weak third quarter and the departure of its CEO. That put even more pressure on the company to deliver a good fourth quarter result, and management came through.

Revenue rose 25% as reported, beating expectations. Product revenue rose 24%, and the company saw 24% growth in billings (or 22% excluding a patent sale). Billings were pretty well-balanced across large, mid-range and small enterprise categories.

Margins were also pretty good. Non-GAAP gross margin fell 40 basis points (BPS) from the year-ago level, but analysts were expecting worse. Operating income rose 28% (again, on a non-GAAP basis) and the operating margin expanded half a point from last year's level on restrained G&A and R&D spending.

SEE: How To Decode A Company's Earnings Report

Plenty of Hard Work Left to Do
While Fortinet management may have been a bit conservative with 2013 guidance, there really wasn't anything that struck me as worrisome. Enterprise IT budget priorities are still up in the air, but I'd be surprised if security doesn't remain near the top of the list of priorities. But that's not to say that it's all smooth sailing from here on for Fortinet.

Due diligence with resellers and customers has turned up the nugget that Fortinet has often been willing to compete on price to gain business from Palo Alto Networks Inc. (NYSE:PANW), Check Point, and Juniper Networks Inc. (NYSE:JNPR), even though it is the market share leader in Unified Threat Management and market leaders aren't typically thought of as price competitors. What's more, Fortinet is working hard to go up-market (larger enterprise customers) and while these customers are not insensitive to price, it is just one of several important considerations. That, then, could put some near-term pressure on margins as the company invests more into marketing.

There's also the more prosaic concern of competition. Cisco Corporation (Nasdaq:CSCO), Check Point, and Juniper have all rolled out new products in Fortinet's core market, and Cisco and Check Point in particular are no slouches when it comes to technology quality and product features. Perhaps it's a bit ironic, but those same due diligence calls suggest a potential benefit to Fortinet's prior willingness to compete on price - many customers seem to think Check Point in particular is more expensive than it actually is, and that could help the company compete against these new product platforms.

SEE: The Pros And Cons Of Price Wars

The Bottom Line
I'm a fan of Fortinet, and I do believe the company's proprietary processing chips and operating system do offer a competitive edge. The problem is that Fortinet also has some very serious rivals with strong technology of their own.

Even so, I think Fortinet could produce long-term revenue growth in the low double-digits. I don't see quite as much incremental margin/free cash flow (FCF) conversion potential, however, so my outlook for FCF growth is pretty close to that of revenue. At a 12 to 13% growth rate from 2012 results, fair value for Fortinet would appear to be in the mid-to-high $20s. That, in turn, suggests that the shares may be 5 to 20% undervalued today - not a tremendously compelling margin of safety given the risks and volatility in the tech sector.

On balance, I'm inclined to buy these shares even with the relatively high valuation. While Check Point and Cisco both could do better, Fortinet is actually doing better today, and I think the company's technology makes it a player to watch, whether it stays independent or gets a bid from a larger tech player.

At the time of writing, Stephen D. Simpson did not own any shares in any company mentioned in this article.

Related Articles
  1. Stock Analysis

    3 Resilient Oil Stocks for a Down Market

    Stuck on oil? Take a look at these six stocks—three that present risk vs. three that offer some resiliency.
  2. Economics

    Keep an Eye on These Emerging Economies

    Emerging markets have been hammered lately, but these three countries (and their large and young populations) are worth monitoring.
  3. Stock Analysis

    Is Pepsi (PEP) Still a Safe Bet?

    PepsiCo has long been known as one of the most resilient stocks throughout the broader market. Is this still the case today?
  4. Investing

    The ABCs of Bond ETF Distributions

    How do bond exchange traded fund (ETF) distributions work? It’s a question I get a lot. First, let’s explain what we mean by distributions.
  5. Stock Analysis

    3 Stocks that Are Top Bets for Retirement

    These three stocks are resilient, fundamentally sound and also pay generous dividends.
  6. Investing News

    Are Stocks Cheap Now? Nope. And Here's Why

    Are stocks cheap right now? Be wary of those who are telling you what you want to hear. Here's why.
  7. Investing News

    4 Value Stocks Worth Your Immediate Attention

    Here are four stocks that offer good value and will likely outperform the majority of stocks throughout the broader market over the next several years.
  8. Investing News

    These 3 High-Quality Stocks Are Dividend Royalty

    Here are three resilient, dividend-paying companies that may mitigate some worry in an uncertain investing environment.
  9. Stock Analysis

    An Auto Stock Alternative to Ford and GM

    If you're not sure where Ford and General Motors are going, you might want to look at this auto investment option instead.
  10. Mutual Funds & ETFs

    The 4 Best Buy-and-Hold ETFs

    Explore detailed analyses of the top buy-and-hold exchange traded funds, and learn about their characteristics, statistics and suitability.
  1. How do dividends affect retained earnings?

    When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
  2. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  3. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  4. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  5. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>
  6. What is the difference between issued share capital and subscribed share capital?

    The difference between subscribed share capital and issued share capital is the former relates to the amount of stock for ... Read Full Answer >>

You May Also Like

Trading Center
You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!