When I last wrote on F5 (Nasdaq:FFIV) in early June, I still liked the prospects for the company and its shares, but I warned that it was likely to be a volatile holding. In the intervening two months or so, the shares have lived up to that prediction – initialing falling another 15%, before rebounding 30% and ending up with a net 11% gain since that June 3 article.
I see little reason to believe that these shares won't remain highly volatile. Although the company should see meaningful benefits from new product launches and a spending recovery in the coming quarters, there is still the spectre of greater competition and a slowing core market looming over the shares. While I continue to believe that F5 is the premier application delivery controller (ADC) company, and that the ADC market is slowing (not declining), the market's uncertainty regarding the company's future is likely to play out in outsized reactions in the stock price.

SEE: Market Cycles: The Key To Maximum Returns
A Good Beat For Fiscal Q3
There was quite a bit of pessimism going into this quarter, but F5 delivered a surprisingly strong set of results. Although those analysts who'd been bullish going into the report certainly celebrated the outperformance, more than a few bearish analysts tried to tamp down the excitement by claiming it was just an aberration.
Revenue rose 5% from the year-ago quarter and 6% from the prior quarter. Product revenue declined 5% and rose 6%, respectively, while service revenue rose 19% and 5%. Sales were boosted by a strong recovery in the telecom market, and though management cited good uptake for non-ADC products like the Advanced Firewall Manager and Application Security Manager, there wasn't much specificity there. 
Margin performance was a good news/bad news proposition – better than expected (and not trivially so), but still not so good on a comparative basis. Gross margin fell about 70bp from the year-ago period and 40bp from the prior quarter. GAAP sales and marketing expenses rose about 9% from last year, helping push GAAP operating income down about 5%. On a non-GAAP basis, income was down 2% and up 10%, good for a six-cent operating beat.

SEE: A Look At Corporate Profit Margins
Will New Intros Leverage An Improving Spending Environment?
IT hardware companies seem to be getting a little more optimistic about the spending environment, particularly in the telecom sector. What's more, multiple sell-side surveys seem to support the idea that ADC purchases still rank relatively high as a priority for enterprise customers.
F5 could further leverage that with the introduction of two new products (the 5000 and 7000) late in this past quarter. New production introductions have been a powerful catalyst for sales growth in F5's past, and bulls are hoping for a repeat performance.
Market And Competition Fears Are Not Going Away
Although F5 continues to score well in a variety of surveys, there is still a lot of fear in the market regarding F5's future prospects. Rival Citrix (Nasdaq: CTXS) has also been showing strong momentum in this market, and it still looks as though the Citrix-Cisco (Nasdaq: CSCO) partnership is moving most of Cisco's former ADC customers to Citrix. It also doesn't help matters that Citrix still retains a significant market share edge in virtual ADCs, a market that continues to grow at the traditional ADC market's expense.
Competition from companies like Citrix, Radware (Nasdaq: RDWR), and A10 is bad enough, but those aren't the only concerns on the Street regarding F5. Some investors question F5's ability to compete with companies like Cisco, Check Point (Nasdaq:CHKP), and Juniper (Nasdaq: JNPR) in security, and not unlike what has happened to Check Point, others fear that F5 may be too high-end for its own good (leading customers to go with cheaper alternatives).
The Bottom Line
I do wonder if F5 isn't going to be more of a trader's stock than an investor's stock for the remainder of 2013. More growth (and more detail) in markets like security, storage, and traffic management would certainly help, as would signs that F5 is taking away some of those former Cisco customers from Citrix.
Even with modest future growth expectations (roughly 4% to 5% long-term free cash flow growth), a fair value of around $100 seems appropriate for these shares. That said, so long as the market remains worried that F5's core market growth is slowing and that margins are likely to shrink, it will be a challenging stock to hold. Investors who can tune out the noise will likely be happy with the long-term returns, but seeing the shares touch $70 again doesn't seem out of the question.
Disclosure – As of this writing, the author has no positions in any of the stocks mentioned.

Related Articles
  1. Mutual Funds & ETFs

    What Exactly Are Arbitrage Mutual Funds?

    Learn about arbitrage funds and how this type of investment generates profits by taking advantage of price differentials between the cash and futures markets.
  2. Investing News

    Ferrari’s IPO: Ready to Roll or Poor Timing?

    Will Ferrari's shares move fast off the line only to sputter later?
  3. Stock Analysis

    5 Cheap Dividend Stocks for a Bear Market

    Here are five stocks that pay safe dividends and should be at least somewhat resilient to a bear market.
  4. Investing

    How to Win More by Losing Less in Today’s Markets

    The further you fall, the harder it is to climb back up. It’s a universal truth that is painfully apparent in the investing world.
  5. Fundamental Analysis

    Use Options Data To Predict Stock Market Direction

    Options market trading data can provide important insights about the direction of stocks and the overall market. Here’s how to track it.
  6. Stock Analysis

    2 Oil Stocks to Buy Right Now (PSX,TSO)

    Can these two oil stocks buck the trend?
  7. Investing News

    What Alcoa’s (AA) Breakup Means for Investors

    Alcoa plans to split into two companies. Is this a bullish catalyst for investors?
  8. Stock Analysis

    Top 3 Stocks for the Coming Holiday Season

    If you want to buck the bear market trend by going long on consumer stocks, these three might be your best bets.
  9. Investing News

    Could a Rate Hike Send Stocks Higher?

    A rate hike would certainly alter the investment scene, but would it be for the better or worse?
  10. Investing News

    Corporate Bonds or Stocks: Which is Better Now?

    With market volatility high, you may think it is time to run for corporate bonds instead of stocks. Before you do take a deeper look into which is better.
  1. How do dividends affect retained earnings?

    When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... 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. 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 >>
  5. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  6. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>

You May Also Like

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!