F5 Networks (NASDAQ:FFIV) is a leading technology provider that optimizes the delivery of network-based applications and the security, performance and availability of servers, data storage devices and other network resources. Its products collectively simplify the management of data center operations and the delivery of services across diverse data center resources. It competes with heavyweights such as Cisco Systems (NASDAQ:CSCO), Citrix Systems (NASDAQ:CTXS) and Juniper Networks (NYSE: JNPR). The company derives around three-fifth of its value from application delivery network, which accounts for around 63% of our current price estimate of $128.
Here we highlight the key drivers that may lead to upside/downside to the stock value:
1. Application Delivery Network (ADN) Market: The global application delivery market grew from $1.9 billion in 2006 to $2.9 billion in 2011, a cumulative average growth rate of 9%.
2. F5 Network’s Application Delivery Network Market Share: At 25% in 2010, F5′s market share witnessed an y-o-y increase of 2%. Historically its market share stood at 16% in 2006.
3. Application Delivery Network Gross Profit Margin: The gross margins increased from 79% in 2006 to close to 83% in 2011.
22% Upside Scenario | $156 Price Estimate
1. Higher than Expected Growth in ADN Market (+9%):
Application delivery networking is the managing, inspecting, modifying, redirecting and securing application traffic going to and from servers. With growth in Internet traffic resulting in data explosion and processing required online, the server market is bound to grow through our forecast period. Additionally, a shift toward cloud computing will also drive growth in this market, as the on-demand computing resources and applications benefit from ADN technologies by keeping data-center build-out to a minimum. We estimate the ADN market to grow to $7.5 billion by the end of our forecast period, growing at an annual rate of around 16%.
The industry is witnessing growth in mobile application delivery. With smartphones and tablets replacing PCs as engines of growth for the semiconductor industry, increased focus on mobile applications could significantly boost the overall market growth rate. If the industry touches the $9 billion mark, we can see a 9% upside to our price estimate.
2. Increase in F5 Networks ADN Market Share (+9%):
F5 Network’s market share has increased from 16% in 2006 to 25% in 2011. With the acquisition of Traffix Systems in February 2012, the company has expanded its Telco-related capabilities which contributed 27% to its last quarter sales. In addition, with Big-IP 11.1 software passing the ISCA tests for network firewalls, the company marked its entry in the expanding firewall solutions market, in February 2012 and saw a growing demand for its VIPRION platforms. On account of the above factors, we expect its market share to increase by 3% in the current year and go up to 38% by the end of our forecast period.
However, there could be scope for further increase with F5 launching the first integrated SPDY gateway, focusing on the growth in mobile application delivery market and the TMOS version upgrade up its sleeve this year. If F5′s market share goes up to 44%, we can see an upside of 9% to our market share.
3. Rising Profit Margins (+1%):
The gross margins for F5 Networks’ ADN division increased from 79% in 2006 to close to 83% in 2011. We estimate the margins to remain constant through our forecast period mainly on account of lower cost, which is a result of a competitive off-the-shelf components market and higher margins that it enjoys by building out low-cost hardware and putting its high performance platform on top of it.
Increased innovation and efficiency could improve margins and even a slight increase to 84% could lead to a 1% upside to our price estimate .
14% Downside Scenario | $110 Price Estimate
1. Lower Growth in ADN Market (-7%):
We estimate the global ADN market to rise by an average 15% through our forecast period. Though the overall prospects of the market look promising, with cloud computing and an exponential increase in Internet traffic, there could be a possibility of the soft economy impacting the growth rate. The year 2011 saw a 12.1% decline in growth rate on account of the economic slowdown, while the financial crisis in 2008 witnessed the ADN market declining by 16%.
A similar slowdown in economic growth in future could negatively impact growth in ADN market. If the market is worth $7 billion instead of the $7.5 billion we forecast, there can be a 7% decline in our price estimate.
2. Fall in F5 Networks Market Share (-5%):
F5 currently holds roughly half the application delivery controller (ADC) market, having long overtaken Cisco as the number one ADC supplier. Gartner forecasts global ADC sales to double to $2.94 billion in 2015 from $1.45 billion in 2011, providing tremendous opportunities in this division. If F5 fails to adequately leverage this growth and monetize the growing opportunity in this market, our estimate might turn out to be too optimistic. In F5′s market share were to increase to 35% instead of 38% we forecast, there could be a 5% downside to our price estimate.
3. Falling Profit Margins (-5%):
F5 has enjoyed high margins for a long time due to the factors mentioned above. However, if its hardware cost keep rising combined with increasing competitive pressure, it could witness a downward push on its margins. If the margins drop down to 77%, our price estimate would decline by 5%.