Outside of companies with big exposure to carrier spending, this has been a fairly upbeat quarter for tech hardware companies. Riverbed Technologies (Nasdaq:RVBD) wrecked that idyll to some extent on Thursday, warning investors that expectations for 2012 were too high. Although investors are booting this stock out of their portfolios on the day after earnings, a closer look at what's going on suggests a possible opportunity may be developing for patient investors.
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Good Fourth Quarter Earnings, but...
Riverbed posted pretty solid results for the fiscal fourth quarter. Revenue rose 23% from last year and 7% from the prior quarter, leading the company to beat the average estimate by a few million dollars. Product revenue was up 6% and ex-government revenue from enterprise customers was up strongly at 23%. Also encouraging, Riverbed's recovery in Europe continues, though the U.S. growth was not so impressive.
Margins were another matter. Hurt by a component shortage (namely hard drives), Riverbed saw gross margin fall a point from the third quarter level. The company did not recoup this through tighter operating expenses (R&D increased about 9% sequentially), though, and operating income fell 4% from the third quarter. (For related reading, see A Look At Corporate Profit Margins.)
... Guidance Grabs the Headlines
Had Riverbed management followed up this result with confirmatory guidance, there wouldn't be much of a story here. But that's not what happened. Management indicated that revenue would be down 8 to 10% next quarter - much worse than the usual seasonal low single-digit decline. What's more, pre-existing analyst expectations for full-year growth in 2012 now sit at the very high end of management's range.
Investors are also likely spooked by trends in North American and non-government customers. A lot of analysts may well be inclined to talk down the recent strength in enterprise sales as an aberration, particularly with that weak first quarter guidance. What's more, depending on Europe as a growth driver doesn't seem like a very strong bet in 2012.
But Look Closer at the "Why"
I understand the sell-off in Riverbed shares. High-multiple tech stocks are all about the growth momentum, and there is a lot of money managed by funds that literally cannot own stocks that are showing negative revisions or revenue contraction. I also get that investors are worried about potential competition from companies like Cisco (Nasdaq:CSCO), Silver Peak and Citrix (Nasdaq:CTXS) as well as moves by others like F5 (Nasdaq:FFIV) that could bring them into competition with Riverbed.
But look at the reason why Riverbed management is taking down numbers. Management expects that there's going to be turbulence due to new product roll-outs (Granite and Stingray), and the first product refresh of its core Steelhead business since 2008. So, not unlike what happened to Apple in the run-up to the launch date of its latest iPhone, buyers are likely to hold off for the new products.
Given that Riverbed has beaten Cisco over the years and claimed the No. 1 spot in WAN optimization, is a new product cycle really a good reason to sell? Do investors really believe that previous loyal customers won't stick around for the new products or that a fresh version of Steelhead won't be just as good (if not better) than the old one? And what about the good growth that Riverbed is seeing in products outside of WAN optimization?
The Bottom Line
Although I like the business at F5 better, I have to admit that this sell-off in Riverbed shares has me very intrigued. The stock still is not especially cheap, even with robust growth assumptions (like low teens free cash flow growth over the next decade), but it is nevertheless undervalued - maybe enough to be worth a buy. There's clearly risk from this product conversion cycle, but until I see real evidence that Cisco (or others) is gaining on them, I have to think that new Riverbed products are a good thing and that the overall growth outlook really hasn't changed that much. (For related reading, see Free Cash Flow: Free, But Not Always Easy.)
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At the time of writing, Stephen Simpson did not own shares in any of the companies mentioned in this article.