F5 Networks a Buy on Growth and Profits

by Hilary Kramer | November 19, 2013 12:30 pm

F5 Networks a Buy on Growth and Profits

I have a new opportunity in the Big Data arena that is a different way to capitalize on the continued growth of Internet traffic and information that I’d like to share with you today.

A recent pullback on a small guidance miss at F5 Networks (FFIV[1]) is giving us a good entry point that I want us to take advantage of ahead of strong growth catalysts.

F5 Networks’ hardware and software help manage Internet traffic across existing hardware and the cloud, with expertise in content delivery and security. The emergence of “virtual servers” over the past several years, alongside the growth in data centers (the warehouses where servers are located) and the explosive expansion in mobile computing at the office, have boosted demand for FFIV’s core hardware/software, known as application deliver controllers, or ADCs.

ADCs are a critical part of “service provider” networks, where telecom, video and other businesses must manage the flow of data across their infrastructure – making sure that content is delivered seamlessly and securely. Think of them as boxes that sit in front of a company’s server and direct traffic. They look at each piece of data coming in, analyze where it’s coming from and where it needs to go, and then redirects, prioritizes or blocks the information as needed. ADCs help servers run a lot smoother by keeping them from having to do all this data analysis on their own.

You may have seen the oft-repeated statement by tech behemoth Cisco (CSCO[2]) that Internet traffic is growing by as much as 40% annually. That means that there is a strong and growing need for these ADCs, making FFIV a great way to play the expansion in data management since the company has the strongest market share for the controllers at about 50%.

Of the roughly $1.3 billion that FFIV makes on the top line, 60% comes from hardware, and 90% of that tally (or 54% of total revenues) comes from its Big IP brand of ADCs, as well as security offerings. The remainder comes from services and maintenance the company provides to clients who have FFIV equipment in the field.

FFIV is not just a box maker. It has a valuable proprietary traffic management operating system (TMOS) that inspects and modifies Internet traffic. TMOS has helped FFIV expand its total addressable market through the years, growing from secure remote access a decade ago, to the growing virtualization arena where several servers can be configured to act like one single unit.

Growth Outside of the Box

Sales have grown at a compounded annual rate of about 20% since the recession, reaching nearly $1.5 billion in the fiscal year that just ended in September. While the year-over-year growth rate has slowed to the mid to high single digits, up about 8% in its recent fiscal year, there are catalysts in place to help quicken the pace over the next few years.

In its fiscal fourth-quarter report last week, the company delivered good results in a period where many networking peers, such as Citrix (CTXS[3]) (which has signed on with Cisco as the latter exited the ADC market) and Riverbed (RVBD[4]) posted poor or just so-so results.

This tells me that despite some softening macro factors that bedeviled other companies, there is continuing demand for FFIV, and the numbers bear this out. Non-GAAP earnings were $1.26 a share, which was nicely ahead of consensus at $1.19, while a 9% jump in revenues to $395 million bested estimates of $384 million.

Despite the strong quarter, the stock has been weak since the report as there are some lingering concerns over guidance. Management guided for fiscal first-quarter revenue of about $395 million, above the expected $389 million, but said it expects earnings of $1.17-$1.20 a share, while analysts had estimated $1.20. The guidance reflects product growth and some near-term margin pressure on its operating margin line, due in part to investing in sales and marketing, which means margins in the first half of the year will be in the mid 30% range before trending back into the high 30% range. This was not a huge guidance miss and the selling looks a bit overdone to me.

Meanwhile, we can use the recent weakness as a buying opportunity. FFIV has been able to grow product sales (after a few quarters of sluggish growth and even a decline in the first and second quarters of this year) as it has launched new software and hardware upgrades. Management also said its installed base of users has a relatively older suite of ADCs in place, ranging from three to six years of service, and even longer, in some cases. That means a refresh cycle has just begun gaining traction.

These are company-specific tailwinds, and should enable FFIV to weather any near-term bumps to see some growth in the years ahead. The emergence of the cloud and security concerns, where 30% of new IP platforms sold by FFIV in the latest quarter had at least one security feature, should also help F5 grow sales of its security features tied to its Big IP platform.

The company could earn as much as $6.10 a share in its next fiscal year that ends September 2015, which would be about 20% growth over the current year’s consensus of $5.10 a share. This assumes revenues of $1.9 billion with margins of 39% in that period, which would add a net cash position of almost $8 a share and push the stock toward $110 within a year.

Endnotes:
  1. FFIV: http://studio-5.financialcontent.com/investplace/quote?Symbol=FFIV
  2. CSCO: http://studio-5.financialcontent.com/investplace/quote?Symbol=CSCO
  3. CTXS: http://studio-5.financialcontent.com/investplace/quote?Symbol=CTXS
  4. RVBD: http://studio-5.financialcontent.com/investplace/quote?Symbol=RVBD

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