There are only a handful of tech companies that aren't seeing significant pressure on their revenue growth these days, so in that respect F5 (Nasdaq:FFIV) is in good company. What's more troubling about F5, though, is the prospect that the company's core market (and its position within that market) has begun to fade significantly. Although F5 is cash-rich and has opportunities to reignite growth with new products for new markets, investors need to appreciate the risk that growth stagnates during this reconstruction period and that valuation alone won't be enough to support the stock.

Discount Brokers Comparison: Your one-stop shop for finding the perfect broker for your investments.

The Luster Of ADC Is Fading At An Increasing Rate
F5 is still the leader in the application delivery controller (ADC) market, but that leadership position is looking less and less impressive. While ADCs are still important tools in managing data network traffic, growth at the high-end has stagnated, while lower-end customers turn to virtual ADCs where F5 holds much less share.

All the while, Citrix (Nasdaq:CTXS) is becoming an increasing threat to F5. For starters, Citrix is benefiting from its partnership with Cisco (Nasdaq:CSCO) and successfully transitioning former Cisco ADC customers to its systems, even though F5 management is also claiming good success in converting Cisco customers. To that end, while different analysts have reported different figures for ADC market share, there seems to be a general consensus that F5 lost share in 2012 and now holds a share somewhere in the low 40%'s. Citrix has won almost all of that (with its share now in the low 20%s). While privately-held A10 Networks is also growing, smaller rivals like Radware (Nasdaq:RDWR), Brocade (Nasdaq:BRCD) and Riverbed (Nasdaq:RVBD) don't seem to be gaining much momentum.

Citrix is problematic for at least two reasons. First, Citrix can (and does) bundle its ADC products with its popular virtualization offerings. While F5 can somewhat answer this with its partnership with VMware (NYSE:VMW) it's certainly not the same. Citrix has also proven adept at advancing virtual ADC technology, so much so that it is estimated to have about half the market (while F5 is below 20% share). With virtual ADCs sometimes costing as little as one-third of traditional ADCs, it can be a compelling threat on the lower end of the business, where F5 is often too feature-heavy (and/or expensive) for what the customers need.

SEE: A Primer On Investing In The Tech Industry

Still Waiting For That Second Act To Start
Every successful tech company eventually faces a point where the market in which it grew to prominence no longer has the growth characteristics to take it much further. Perhaps it's early to say that about the ADC market, but I don't think so.

Certainly there is more that F5 can do with ADCs. New products will support more modules, and F5 is looking to modules like application firewall and policy enforcement software to take advantage of growth in security and toll-free mobile data, respectively. The trouble is, though, that these products are likely more appealing to higher-end customers and that's where rivals like Check Point (Nasdaq:CHKP) and Palo Alto (Nasdaq:PANW) answer with purpose-built high-performance products of their own.

As I've said before, markets like security and storage can add some juice back to F5's ADC prospects, and although Citrix has the early lead in virtual ADCs, I wouldn't rule out a competitive response from F5. Additionally, there are potential “second act products” like diameter routing to consider, though Oracle (Nasdaq:ORCL) (through its acquisition of Acme Packet) is not a rival to take lightly, nor incumbent Tekelec.

SEE: Analyzing An Acquisition Announcement

The Bottom Line
My biggest fear on F5 is that the core high-end ADC market is close to saturation, and that F5 will find it difficult to do more than refresh its installed base with future product cycles. At the same time, I worry that the combination of virtual ADCs and the migration of smaller businesses towards options like Amazon's (Nasdaq:AMZN) AWS will hollow out the medium-sized and small-business market segments.

As a result, I've cut back my growth estimates pretty substantially. I'm now looking for revenue growth of 7% and free cash flow growth of about 5% (these are 10-year CAGRs). Interestingly, that still points to a fair value of about $100, or about $85 excluding all of F5's net cash. Consequently, I have to say that the market really has soured on F5 – so much so that I'm still somewhat bullish on the stock. While I do worry that F5 is dead money for the next couple of quarters (absent a big recovery in market share/product revenue growth) and I'm aware that value arguments seldom work in tech, this company (and these shares) isn't done yet.

At the time of writing, Stephen D. Simpson owned shares of VMware.

Related Articles
  1. Retirement

    The Investing Risk Of Underfunded Pension Plans

    Determine the risk to a company's EPS and financial condition resulting from an underfunded pension plan.
  2. Personal Finance

    How Stock Market Indexes Changed Investing

    Find out how the first market averages were calculated and what they mean for investors today.
  3. Active Trading

    Investing Lessons From Across The Pond

    There's a lot to learn from Anthony Bolton, who is known as Europe's Peter Lynch.
  4. Investing Basics

    Why do Debt to Equity Ratios Vary From Industry to Industry?

    Obtain a better understanding of the debt/equity ratio, and learn why this fundamental financial metric varies significantly between industries.
  5. Investing

    Blockchain Technology To Revolutionize Traditional Banking

    Blockchain technology is being taken seriously by the financial sector as it may prove to be a great disrupter to the traditional banking industry.
  6. Entrepreneurship

    How Does Hinge Work and Make Money?

    Learn about Hinge's business model and its competition in the dating app field. Find out in which cities Hinge currently offers its services.
  7. Economics

    The Problem With Today’s Headline Economic Data

    Headwinds have kept the U.S. growth more moderate than in the past–including leverage levels and an aging population—and the latest GDP revisions prove it.
  8. Personal Finance

    A Day in the Life of an Equity Research Analyst

    What does an equity research analyst do on an everyday basis?
  9. Investing

    Three Companies That Will Benefit From Online Gaming

    Certain companies stand to benefit from the increasing popularity of the online gambling industry in the U.S., as well as its expanding legalization.
  10. Mutual Funds & ETFs

    ETF Analysis: PowerShares S&P 500 Downside Hedged

    Find out about the PowerShares S&P 500 Downside Hedged ETF, and learn detailed information about characteristics, suitability and recommendations of it.
RELATED TERMS
  1. Equity

    The value of an asset less the value of all liabilities on that ...
  2. Profit Margin

    A category of ratios measuring profitability calculated as net ...
  3. Quarter - Q1, Q2, Q3, Q4

    A three-month period on a financial calendar that acts as a basis ...
  4. Debt Ratio

    A financial ratio that measures the extent of a company’s or ...
  5. Middle Market

    Definition of middle market
  6. Price-Earnings Ratio - P/E Ratio

    The Price-to-Earnings Ratio or P/E ratio is a ratio for valuing ...
RELATED FAQS
  1. What is the formula for calculating compound annual growth rate (CAGR) in Excel?

    The compound annual growth rate, or CAGR for short, measures the return on an investment over a certain period of time. Below ... Read Full Answer >>
  2. What is the formula for calculating weighted average cost of capital (WACC) in Excel?

    When analyzing different financing options, companies need to look at how much it will cost to fund operations. There are ... Read Full Answer >>
  3. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  4. When does the fixed charge coverage ratio suggest that a company should stop borrowing ...

    Since the fixed charge coverage ratio indicates the number of times a company is capable of making its fixed charge payments ... Read Full Answer >>
  5. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  6. What is the difference between the return on total assets and an interest rate?

    Return on total assets (ROTA) represents one of the profitability metrics. It is calculated by taking a company's earnings ... Read Full Answer >>

You May Also Like

COMPANIES IN THIS ARTICLE
Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!