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Will Investors Find Safe Haven With Network Security Company?
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Fortinet Inc.
Sunnyvale, Calif.
408-235-7700
fortinet.com
Lead underwriters:
Morgan Stanley, JPMorgan and Deutsche Bank
Offering price: $9-$11
Expected date: week of Nov. 16
Ticker: FTNT
THE BUZZ
Security software has definitely been a bright spot in the market. Such old standbys as McAfee and Bluecoat Systems (NasdaqGS:BCSI - News) have hit 52-week highs lately, while more recent entrants such as Sourcefire (NasdaqGM:FIRE - News) and ArcSight have improved drastically on their IPO prices.
Fortinet would be the first IPO in this space since ArcSight (NasdaqGM:ARST - News) came out in February 2008. It specializes in a rising field called unified threat management, or UTM. UTM brings together all types of security software into one system.
Scott Sweet, managing partner at IPO Boutique, upgraded Fortinet to a strong buy Monday after hearing buzz about strong demand for the firm's shares.
"Fortinet is regarded as a premier vendor and some analysts consider (it) the top player in unified threat management," he wrote in a note. "Fortinet's management is top- notch and has a history of success."
Morningstar analyst Sunit Gogia agrees that Fortinet will be the leading UTM vendor for small and midsize businesses in the near term. In a Sept. 25 note, however, he expressed concerns about growth prospects farther out. He pointed out that larger security players have gotten interested in the space with McAfee (NYSE:MFE - News) and Check Point (NasdaqGS:CHKP - News) both offering competing products.
THE COMPANY
Fortinet was founded in 2000. Its lead product is the FortiGate appliance, which combines firewall, VPN, anti-virus, intrusion prevention, Web filtering, anti-spam, and WAN acceleration. The line is numbered according to the size of the customer. Fortinet 30 is for small business and branch offices and goes for as little as $300. At the other end of the scale, Fortinet 5000 sells to large enterprises for as much as $1.1 million.
Clients can subscribe to FortiGuard, which keeps them up to date on emerging threats. Large deployments are typically sold with FortiManager and FortiAnalyzer to manage the system. The firm also offers some appliances for specific technologies including e-mail, databases, Internet and so on.
As of Sept. 30, Fortinet shipped 475,000 appliances to about 75,000 customers, using 5,000 channel partners. As is often the case with maturing tech companies, service revenue is providing an ever-greater portion of the top line. So far this year, product sales have been nearly flat, but service revenue has grown 35%.
Redpoint Ventures and Meritech Capital each own significant but not controlling stakes in the company.
RISKS/CHALLENGES
Fortinet is still in startup mode, still run by its co-founders, and it just turned profitable in the third quarter of 2008. It has yet to prove itself as an established tech player.
As noted, Fortinet faces increasing competition from larger rivals. This is especially the case since it says in its prospectus that it wants to increase its business with large enterprises and government, which have traditionally been big-vendor clients. Analyst Gogia notes that big customers "also typically prefer to use best-of-breed products for each security function, making UTM appliances less attractive to this segment of the market."
The company warns that results can be lumpy. There tends to be an end-of-the-quarter rush in shipments as salespeople try to make their quotas. Also, it recognizes revenue from subscriptions and contracts that it doesn't actually have in hand yet, so cancellations won't hit the top line until the following quarter.
Like virtually all tech startups, Fortinet has to protect its intellectual property from competitors. This can sometimes involve expensive patent suits.
THE RESULTS
Revenue in the first nine months of the year rose 18.8% over last year to $181.4 million. The firm reported net income of $16.2 million, after losing $580,000 in the year-ago period.
USE OF PROCEEDS
Fortinet expects to raise $52 million from its portion of the 12.5-million-share offering. It will use the money for working capital and general corporate purposes.
THE MANAGEMENT
Ken Xie
President, CEO and director
Co-founded the firm. Previously he founded NetScreen Technologies, which was bought by Juniper Networks (NYSE:JNPR - News) in 2004, and Stanford Infosystems. He has also been security architect at Healtheon and Philips Semiconductors (NYSE:PHG - News). He holds an MS from Tsinghua University.
Michael Xie
Vice president of engineering and chief technical officer
Co-founder. Previously he was VP of engineering at ServGate, software director and architect for NetScreen, and a software engineer for Milkyway Networks. He holds an MS in electrical engineering from the University of Manitoba, and also an MS in automobile engineering from Tsinghua University.
Kenneth Goldman
Vice president and CFO
Joined in 2007 from the same position at Dexterra. From 2000 to '06, he was CFO of Siebel Systems, now part of Oracle (NasdaqGS:ORCL - News). From 1996 to 2000 he was CFO of Excite@Home. He is also on the board of BigBand Networks (NasdaqGM:BBND - News), Infinera (NasdaqGS:INFN - News) and Starent Networks (NasdaqGS:STAR - News). He holds an MBA from Harvard Business School.
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