F5 Networks Becoming A Multi-Market Threat

By Stephen D. Simpson, CFA | April 20, 2012 AAA

As I have mentioned in prior write-ups on F5 Networks (Nasdaq:FFIV), I have a certain bias with regards to this company - namely, I hope it stumbles just enough that I can swoop in and buy up some shares. As this quarter shows, not only is F5 maintaining (if not extending) its lead in its core ADC market, but it's also seeing good initial results in incremental growth markets. While the valuation remains quite high, so too is the level of execution and the total addressable market at F5 Networks.

A Mostly In-Line Second Quarter
F5 had a good quarter, though it didn't really trounce the expectations out there. Revenue rose about 22% year over year and a little more than 5% sequentially. Product revenue rose 18 and 4%, with solid growth in the government and telco sectors. The financial services vertical was soft, but I think investors sometimes read too much into these quarter-by-quarter end market reads.

Profitability was where F5 stood out. GAAP gross margin improved more than a point and exceeded most estimates. Operating income rose 26% as the company gave some of that back in higher research and development and marketing spending.

Guidance Seems Good Enough
F5's third quarter guidance was OK, but just OK - and very slightly below pre-existing estimates. Normally, a small beat and no raise would be enough to have tech investors looking for blood, but there were quite a bit of conflicting analysts reports before this quarter about the strength of the business. As such, investors had likely steeled themselves for a disappointment and were relieved to see the business on plan and on target.

SEE: Can Earnings Guidance Accurately Predict The Future?

New Products, New Markets
Although some have worried that F5 is vulnerable to Citrix Systems (Nasdaq:CTXS) and a resurgent Cisco Systems (Nasdaq:CSCO) in the ADC market, those worries seem premature. Gartner estimates that F5 has over 60% of the market share in advanced platform ADC, with Citrix and Cisco far behind. However, F5 doesn't have quite the same lead in the overall ADC market and it's true that companies rarely hold on to this kind of market share for long in growing markets.

That said, it's not like F5 is helpless when it comes to fending off Citrix or Cisco. The company's TMOS operating system is a differentiating advantage, and the new Viprion 4480 supposedly has six times the Layer 4/7 capacity of current competing products.

New markets also continue to drive this story. F5 reported some large deals in its data center firewall business, suggesting a real chance to compete with Juniper Networks (NYSE:JNPR) and Check Point Software (Nasdaq:CHKP) in what could be a sizable addressable market.

But that's not all. The company's recent acquisition of Traffix gives it new exposure to the mobile market, and there are still sizable opportunities in areas like storage and optimization, as well as cloud-driven traffic steering and security.

SEE: The Wonderful World Of Mergers

The Bottom Line
With an addressable market today of roughly $9 billion, F5 has plenty of opportunity left to grow and the tricky thing about addressable market estimates is that they often miss entirely new markets that develop along the way. Cisco shows quite clearly that nothing is ever guaranteed (in terms of share or valuation multiples), but F5 looks like a long-term winner.

Right now, I expect about 13% free cash flow growth over the next decade through a combination of strong revenue growth and declining free cash flow margin. The bottom line of all that is that F5 seems to be worth more than $140 today which is not enough to tempt me to buy today, but should a sell-off come again I will certainly reconsider it.

SEE: Sympathy Sell-Off: An Investor's Guide

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At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.

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