Juniper Another Disappointing Networking Story

By Stephen D. Simpson, CFA | August 03, 2011 AAA

There is no point in pretending that there's good news in the networking sector these days. A few companies (like Meru Networks (Nasdaq:MERU)) seem to be meeting reduced expectations, but the story for companies like Cisco (Nasdaq:CSCO), Alcatel-Lucent (NYSE:ALU), F5 (Nasdaq:FFIV), Riverbed (Nasdaq:RVBD), and Juniper (Nasdaq:JNPR) is unfortunately dominated by disappointment. While Juniper's guidance for 2011 did indeed come in below guidance, and may yet be hard to meet, this is a stock that investors may want to consider once the tech sell off abates.

TUTORIAL: The Industry Handbook: The Semiconductor Industry

Disappointing Results, Worse Guidance
Juniper reported that revenue rose almost 15% on a year-on-year basis, and 2% sequentially, for the second quarter. That doesn't sound so bad, but it was below guidance and the first sub-20% result in quite a few quarters.

There are a few different ways to slice and dice Juniper's results. Overall infrastructure sales were up almost 23%, with 33% growth in switches and 21% growth in routers, while service revenue fell 8%. Looking at it differently, the IPG business (which competes mostly with Cisco, but also Alcatel and Hewlett-Packard (NYSE:HPQ) saw revenue up 25% from last year and up nearly 4% on a sequential basis. The SLT business, however, was down 8% from last year and 4% sequentially; results that suggest companies like Check Point (Nasdaq:CHKP), F5, and Riverbed are gaining some share.

Profit performance was not encouraging either. Gross margin fell more than three full points (on a GAAP basis), with product gross margin doing only slightly better. Operating income fell close to 8% and margins dropped three and a half points. Investors should also note the rather sizable amount of stock compensation here and the resulting larger discrepancy between GAAP and non-GAAP results. (For more on margins, see Analyzing Operating Margins.)

Guidance Prunes the Stock
A bad quarter in a nervous market is bad enough, but Juniper's new guidance is likely what really disturbed investors. Where the Street had been looking for growth in the neighborhood of 20%, the expectation now is about 6 or 7% lower. What's more, there may be more downside in store - Juniper's guidance seems to demand a healthy fourth quarter rebound and rarely do companies miss once and not again shortly thereafter.

The Horizon - Sunny, with Some Clouds
Juniper looks to have a good news/bad news future shaping up. Four significant new products should ramp up next year, but these may continue a shift away from higher-margin products. What's more, continued weakness in the second half of the year could have enterprises pushing back their order schedules. On a more positive note, Juniper does sell a large percentage of its revenue into the carrier market (Verizon (NYSE:VZ) and AT&T (NYSE:T) are major customers) and their network demands are such that further spending looks like a "when, not if" question.

The Bottom Line
Just as Juniper played a part in submarining Cisco's perpetual growth story, competition from the likes of Check Point, Fortinet (Nasdaq:FTNT), F5, and Riverbed is a threat to Juniper. Said differently, there's usually an adjustment period when the hunter becomes big enough that it itself becomes one of the hunted.

Still, Juniper has a range of good products serving growing markets. Moreover, considering a pretty lousy scenario (on the order of 10% compound revenue growth for the next five years and no recovery in free cash flow margin from last year's level) still leaves these shares looking undervalued. It's true that demand could fall off even more if there is another recession or multi-year global deleveraging malaise, but Juniper looks like one of the relatively few networking companies that is priced with fairly little downside and quite a bit of upside. (For more on free cash flow, see Free Cash Flow: Free, But Not Always Easy.)

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