F5 Networks (NASDAQ:FFIV) designs and sells application delivery controllers (ADC), a hardware appliance used in data centers, with an aim to optimize the delivery of network-based applications as well as the security, performance and availability of servers, data storage devices and other network resources. Despite the economic slowdown, F5 has posted revenue growth for 15 consecutive quarters, albeit at a slower growth rate. In addition, it has had consistent operating margins, boasts a solid balance sheet with no debt and has strong cash flows.
However, F5’s stock price has declined by over 30% in the last year from $138 in April 2012 to less than $90 at present. We believe that the decline in stock price is more on account of macro headwinds as F5 continue to have strong fundamentals. It has a rich pipeline of products planned for launch in 2013, and an expanding sales force to drive future sales opportunities for its products. Rising Internet traffic, a shift to cloud-based services and increasing data center virtualization are some of the trends that contribute to the robust growth in the application delivery networking market (ADN). We believe that F5 is well equipped to leverage expanding opportunities in the market and re-accelerate growth in its product revenue hereon.
Our price estimate of $130 for F5 Networks is at a significant premium to the current market price. In this article we discuss certain factors that support our rationale.
Current Trends That Drive Growth In The ADN Market
1. Growing internet traffic
With increasing worldwide Internet penetration, the global IP traffic has increased eightfold over the past 5 years and is estimated to grow at a CAGR of near 30% from 2011 to 2016.  There is an increasing adoption of advanced video communications in the enterprise segment which will fuel growth in enterprise traffic. Enterprise Internet traffic is expected to grow at an annual rate of 18%. 
The core function of F5′s products is load balancing that distributes increasing Internet traffic evenly across multiple servers in a date center. Thus, rising Internet traffic increases the target market size for F5’s product portfolio.
2. Shift to cloud-based services and data center virtualization
As organizations transform their own data centers, they are increasingly turning to external third-party cloud providers for services and storage to lower their capital and operating costs. To accommodate the dynamic needs of their clients, cloud providers are building large virtualized data centers to host a constantly changing mix of on-demand resources. Research firm Forrester projects the global market for cloud computing to increase from $41 billion in 2011, to $241 billion by 2020. 
Factors That Can Help Increase F5’s Share In The ADN Market
1. New product development to increase competitiveness
F5 has a strong customer focus and has developed technology partnerships and alliances with major application vendors, including Oracle and SAP. It also works closely with two major server virtualization vendors, Microsoft and VMware, to help its customers get the most out of their virtualization deployments. F5 has collaborated with industry leader Bluelock to migrate its online community, Dev Central, to a cloud environment. Additionally, last year it also announced a new global cloud licensing program developed for Infrastructure-as-a-service (Iaas) cloud providers that offers benefits to providers, customers and channel partners alike.
F5 Networks claims to be working on the most significant product line refresh in several years. It has a gamut of new products and software solutions planned for launch in 2013, which it believes will help boost demand and create new revenue growth opportunities for the future.
F5′s upcoming new release of TMOS, code-named Solar, offers approximately 76 new areas of functionality for TMOS, which will help expand its addressable market in the future. In addition, the company has a number of new ADC platforms and VIPRION products which should help re-accelerate growth in demand.
The company witnessed a 6% increase in the proportion of revenue from new businesses last quarter, and we expect the contribution to increase in the coming quarters. 
2. Increasing headcount to drive sales
F5 expanded its employee base by 22% in 2012 and added another 95 employees in Q1 2013. Foreseeing a higher demand for its product in the future, F5 intends to add another 100 employees in the current quarter. In addition to expanding its product base, the company is also focusing on product training to ensure that its sales force is able to maximize the advantage of its new products portfolio.
We believe the increase in sales force will help F5 leverage the rapidly expanding product portfolio and steer demand for its products in the future.
3. Accelerating momentum in security solutions
With the explosion of data and processing required online, security has become a major concern for most enterprise, and thus, this is one segment bound to witness tremendous growth in the coming years. With its BIG-IP 11.1 software passing the ISCA Labs test for network firewalls, F5 entered the Internet firewall market in February 2012. In addition to improving products, the company is coming out with innovative programs to boost its security solutions sales. Its security module sales witnessed strong growth in Q1 2013.
F5’s upcoming TMOS refresh will include a range of new security as well as service provider offerings and products to enable cloud architecture. Its application delivery firewall solution is the industry’s first solution that combines network firewall, application security, access management and DNS security with traffic management while confirming to industry leading performance and scalability.
4. Focus on mobile application delivery
As the number of remote workers and mobile customers grow, enterprise demand for mobile application delivery is on the rise. Chrome, Amazon Silk and Mozilla Firefox are the standards that are becoming increasingly important for remote users who need a more efficient traffic flow that consumes less bandwidth on their mobile devices. Keeping this in mind, Google (NASDAQ:GOOG) designed its SPDY application-layer protocol, which provides minimal latency while transporting content over the Web via the typical HTTP protocol.
Last year, F5 announced updates to application delivery optimization that made BIG-IP the first ADC on the market to support Google’s SPDY protocol. The company’s application delivery optimization offering provides a better mobile user experience, optimizing image delivery and rendering of web pages in a much quicker environment. We estimate F5’s focus on mobile application delivery to further increase its share in the ADN market.Notes:
- Cisco Visual Networking Index: Forecast and Methodology, 2011-2016 [↩]
- Cisco Visual Networking Index: Forecast and Methodology, 2011-2016, Cisco, May 30, 2012 [↩]
- More Predictions on the Huge Growth of Cloud Computing, Wall Street Journal, April 21, 2011 [↩]
- F5 Networks’ CEO Discusses F1Q13 Results – Earnings Call Transcript, Seeking Alpha, January 23 [↩]