Fortinet IPO: Joining the Hot Network Security Sector

The company has had positive cash flow from operations every fiscal year since 2005. In 2009, 55% of total revenue was services revenue. With zero debt and a pile of cash on hand, this company is poised to take advantage of a growing security market.

High SG&A Expense and Low Margin

Once development costs have been recouped, software companies tend to have small expenses. For smaller companies, the difficult part is developing and selling the products. The following table shows that even though Fortinet decreased its Selling/General/Admin Expenses (SG&A) year over year, in 2009 SG&A still accounted for 45% of its revenue.

Year

2009

2008

2007

2006

Gross Margin

72%

69%

64%

67%

Selling/General/Admin. Expenses ( SG&A)

45%

49%

60%

54%

Research & Development

17%

17%

18%

17%

Operating Margin

10%

2%

-14%

-5%

Over half of the company’s 2009 net income was from tax expense, which makes trailing P/E of 22 much lower than forward P/E of 46.

Main Tech/Software/Network ETFs

Fund Name (Ticker)

Net Assets

Expense Ratio

PowerShares QQQ (QQQQ)

16.23B

0.2%

Technology Select Sector SPDR (XLK)

4.25B

0.2%

iShares S&P North Amer Tech-Software (IGV)

307.09M

0.5%

iShares S&P North Amer Tech-Multimd Ntwk (IGN)

178.02M

0.5%

On the other hand, if you want to short tech sector, you might use Short QQQ ProShares (PSQ)

Conclusion

According to Yale professor Robert Shiller, the efficient markets theory represents one of the most remarkable errors in the history of economic thought. Today, the theory has given way to counterintuitive hypotheses about human behavior, psychological models of decision making, and the irrationality of the market. Investors overreact, under react, and make irrational decisions based on imperfect data, according to Justin Fox, author of The Math of the Rational Market.

Investors generally should pass on buying hot IPOs due to the lack of trading history. Also, new issues can be more volatile than more mature stocks when lockup period expires. During this period, which usually lasts 90 to 180 days from the IPO, company insiders are forbidden to sell any of their shares. If no change in trade patterns occurs at this time, it may tell you that Fortinet’s insiders, who currently hold 48% shares, are bullish.

I will keep this company in my watch list.

Disclosure: Author is long QQQQ. Data are from Google and Yahoo Finance as of March 18, 2010.

About the author: Hao Jin

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