Cloud Competition: Morgan Stanley Downgrades Fortinet, Raises Palo Alto Networks' Price Target

Public cloud stocks have underperformed the broader market in recent years, and the market is only pricing in 5-percent topline growth through the end of the decade, according to an industrywide Morgan Stanley report.

The sell-side firm's analysts project topline growth of 9 percent in the sector, but said that not all companies will benefit equally from the growth over the coming years.

The Analysts

Morgan Stanley's team of equity analysts led by Melissa Franchi downgraded Fortinet Inc FTNT from Overweight to Equal-weight with an unchanged $53 price target. The firm maintains an Overweight rating on Palo Alto Networks Inc PANW with a price target lifted from $205 to $224.

The Thesis

On average, security stocks have gained just 34 percent in value over the past three years while the broader software group generated an average return of 80 percent, Franchi said in a research report. (See the analyst's track record here.)

A survey among chief information officers shows an acceleration in adoption of the public cloud to the point where 44 percent of applications will move to the cloud by 2020, up from 20 percent today, the analyst said. 

Encouragingly, 80 percent of cloud spend will be made by security vendors, Franchi said. Under a base case scenario, security spending will rise from $32 billion in 2016 to $46 billion, the analyst said. The math implies a 9-percent compounded annual growth rate and bodes well for companies that have "optimal business models" for the cloud, including Palo Alto Networks, she said. 

Analyst: Palo Alto Can Broaden Market Position

Palo Alto is "well-positioned" to increase its already leading market position in network security through cloud security services, Franchi said. The company boasts a broad portfolio including the following, the analyst said:

• Virtual firewalls.
• End-point security.
• Cloud access security brokerage.
• Cloud compliance through the recent acquisition of Evident.io.

Rival firewall vendors are focusing on extending their portfolio toward the cloud opportunity, but Palo Alto stands out in the crowd, the analyst said. The company benefits from its focus on software tech — as opposed to hardware — that can more easily be extended into the cloud, according to Morgan Stanley. 

Related Link: 3 Reasons Why Morgan Stanley Says Palo Alto Is A Software Standout

Fortinet: Moving To The Sidelines

Fortinet investors are encouraged to move to the sidelines despite the company transitioning its solutions to cloud-based environments, Franchi said.

The problem: Fortinet focuses on custom-built, ASIC-based appliances, but any advantage it has could be "blurred over time," as more deployments from competitors come to the market in the form of software, the analyst said. 

Fortinet's strengths in branch firewalls and UTMs are "likely less sticky" than other areas of the broader network security architecture, Franchi said. Enterprises will increasingly shift toward applying branch security policy over the longer- erm through a cloud-based solution as opposed to Fortinet's on-premise branch firewall, she said. 

Price Action

Shares of Palo Alto Networks were trading higher by 0.15 percent at the time of publication Wednesday, while shares of Fortinet were lower by 0.85 percent.

Related Link:

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