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.

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