F5 Networks, Inc. (NASDAQ:FFIV) took a beating last week, seeing its stock tumble some 20% on disappointing earnings and a poor 2013 outlook, but is the news really all that bad? With the company’s positioning in an exciting and high growth industry, it’s tough not be intrigued, to not at least take a look at the stock. But I think the stock could be low for a reason.
Image: F5 Networks, Inc. (NASDAQ:FFIV)
Notable Headwinds
Fiscal first quarter sequential revenue growth was a mere 0.8%, which suggests that second quarter revenues will fall by 4.2% sequentially. Revised full year expectations put this year’s earnings equal to last year, with no growth.
Margins have began contracting, which is in part leading to poor EPS growth expectations.
A couple of F5 Networks, Inc. (NASDAQ:FFIV)’s largest customers account for 17% of revenues (Avnet Technology) and 14% (Tech Data).
The majority of weakness is in the telco space, which is F5’s largest segment (accounting for over 25% of revenues last year).
F5 Networks, Inc. (NASDAQ:FFIV) noted that the telco space has seen notable press related to delayed funding for several projects and hesitation related to sign new orders, thanks to budget constraints.
At the end of 2012 some 23 hedge funds were long the stock, with its top hedge fund owner being Lee Ainslie’s Maverick Capital, but the stock made up only 1.2% of its total 13F portfolio (see which hedge funds were dumping F5).
Competition
Piper Jaffray has also noted that F5 is losing market share in the application delivery controller market to the likes of Citrix Systems, Inc. (NASDAQ:CTXS). Citrix has a solid presence in the remote connectivity and work force productivity segment, with an increasing interest in cloud computing. In reality, Citrix offers investors a great way to invest in two high-growth verticals.
Last quarter results for Citrix showed 15% EPS growth year over year and a 7% beat of consensus expectations, managing to see over 15% growth across each of its four major segments, yet, the notable weakness from F5 could signal things to come for Citrix.
Both F5 Networks, Inc. (NASDAQ:FFIV) and major peer Citrix Systems, Inc. (NASDAQ:CTXS) have historically traded in line with each other. Of late, there is a large divergence, with F5 trading at 21 times earnings and Citrix at nearly 37 times.
What’s this mean? Either F5 is undervalued, or Citrix Systems, Inc. (NASDAQ:CTXS) is overvalued. I think Citrix will be the next shoe to drop in the industry. Industry headwinds will be too much to justify Citrix maintaining its premium valuation. The convergence of the two stocks’ multiples becomes even more likely when you consider the fact that they both have similar expected EPS growth (see below).
Industry Shakedown
As with any of the high-margin tech sectors, there are a number of competitors looking to get a piece of the market share. Cisco Systems, Inc. (NASDAQ:CSCO) makes and sells IP based networking products for communications. Cisco offers a complete line of routers and switching products for managing communications among local and wide area computer networks.
Cisco Systems, Inc. (NASDAQ:CSCO) in reality is the undisputed leader in the communications equipment market, with a leading market share (60%) of Ethernet switching, according to IDC. Cisco also leads the the overall routing market, with more than 50% market share. Cisco really is a giant in equipment, with a market cap in excess of $100 billion.
Despite its geographical and product diversity the company’s sheer size limits its growth. However, the bright spot is its dividend. Cisco recently upped its dividend payment by 75%, and it currently yields 3.17% (see all five forgotten tech dividend payers).
Juniper Networks, Inc. (NYSE:JNPR) develops products for network infrastructure, primarily offering routing and switching products that are used to control network traffic. Its primary segment (80% of revenues) is platform systems, which offers scalable routing and switching products. However, Juniper has had a hard time putting a meaningful dent into Cisco Systems, Inc. (NASDAQ:CSCO)’s market share in routing and switching.
Late last week Barclays downgraded the stock from overweight to equal weight (lowering its price target to $19), driven by the fact that F5 Networks, Inc. (NASDAQ:FFIV)’s fiscal 2Q earnings missed due to a slowdown in U.S. telco sales, where Juniper gets two-thirds of its revenue.
At the end of 2012, Juniper Networks, Inc. (NYSE:JNPR) had some of the most robust interest from hedge funds; this includes 29 funds long the stock after a 21% increase form the third quarter. The names owning the stock are also very notable, with billionaire Ken Griffin’s Citadel Investment Group as an investor (check out all the hedge funds loving Juniper).
Riverbed Technology, Inc. (NASDAQ:RVBD) is right alongside F5 Networks, Inc. (NASDAQ:FFIV) in seeing severe sell-off pressures. The tech company is down 25% year to date on concerns over headwinds in its core WAN optimization business. Riverbed posted mixed results last quarter with revenue below estimates. However, Riverbed’s WAN niche market is expected to grow quite nicely over the interim, given the return on investment derived from Riverbed’s WAN products.
Unlike Juniper Networks, Inc. (NYSE:JNPR)’s 29 hedge fund owners at the end of 2012, Riverbed Technology, Inc. (NASDAQ:RVBD) had only 23 owners. Yet, this was a 15% increase from the third quarter and includes billionaire Ken Griffin, who owns the second largest Riverbed position among hedge funds (check out Ken Griffin’s cheap stock picks).
By the Numbers
From a valuation standpoint, F5 now appears to be trading much more in line with other communications and virtualization peers.
| F5 | Cisco | Juniper | Citrix | Riverbed | |
| Forward P/E | 13 | 10 | 13 | 19 | 11 |
| Price to Sales | 4.1 | 2.3 | 2.1 | 5 | 2.8 |
What’s notable about how the valuation stacks up is that Riverbed appears to be rather cheap, trading close to the industry giant Cisco. This is even more intriguing considering the fact that Riverbed is expected to grow EPS nearly three times as fast as Cisco over the next five years:
| F5 | Cisco | Juniper | Citrix | Riverbed | |
| 5-Yr. Expected EPS Growth | 15.30% | 8.30% | 15% | 16.70% | 22.50% |
The one variant view I would caution about Riverbed is that its ROE and balance sheet are among the worst when compared to the peers listed:
| F5 | Cisco | Juniper | Citrix | Riverbed | |
| Return on equity | 21% | 18% | 3% | 12% | 7% |
| Debt ratio | 0% | 17% | 10% | 0% | 28% |
Don’t Be Fooled
The communications equipment industry has been growing robustly as the demand for network capacity continues its up and to the right trend, which has only been exacerbated by the increase in tablets and smartphones. I think operating margin pressure will continue to be a headwind for F5 Networks, Inc. (NASDAQ:FFIV), and even though the valuation seems compelling (cheap) I think industry headwinds will bring the industry valuation more in line with F5 in the near future.
Marshall Hargrave has no position in any stocks mentioned. The Motley Fool recommends Cisco Systems, Inc. (NASDAQ:CSCO), F5 Networks, and Riverbed Technology. The Motley Fool owns shares of F5 Networks and Riverbed Technology, Inc. (NASDAQ:RVBD).
