Despite the economic slowdown, F5 Networks (NASDAQ:FFIV), one of the leading technology providers that optimizes the delivery of network-based applications, closed its fiscal 2012 with $1.38 billion in revenues, marking a 20% increase over 2011. In Q1 2013, the company posted revenue growth for the 15th consecutive quarter, albeit at a slower growth rate. In addition, F5 continued to maintain a solid balance sheet with no debt, a strong cash flow and consistent operating margin.
Despite the strong fundamentals, F5′s stock price witnessed the sharpest fall in the last two years, earlier this month, as the company lowered its revenue target for Q2 2013 to $350.2 million compared to its earlier estimate of $370-$380 million. A sharp decline in revenue from telecommunication (telco) customers and the US federal government are the primary reasons for the weak estimate. While it had a strong pipeline of deals at the start of the quarter, F5 experienced difficulty in closing certain deals as customers hesitated to release purchase orders. F5 is expected to release its Q2 2013 earnings on Wednesday, April 24.
Believing that its competitiveness in the market remains intact, F5 claims that a slowdown in orders from North America and to a lesser extent from EMEA has lowered demand for its products. While we agree that the slowdown in orders is a cause of concern, we continue to believe that the company has strong fundamentals to support a higher valuation. In this article we discuss certain factors to support our view.
Growth Potential In The ADN Market
Rising Internet traffic, an increasing shift towards cloud-based services and data center virtualization are some of the factors driving growth in the global application delivery networking (ADN) market and will continue to do so in the future.
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%. 
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. 
New Product Development To Increase F5′s Competitiveness
F5 can benefit from the above trend in two ways: first, as cloud providers deploy its products within their data centers, and second, as customers deploy F5 products to switch traffic quickly and easily between their own internal resources and the cloud. The core function of F5′s products is load balancing that distributes increasing Internet traffic evenly across multiple servers in a data center. Thus, rising Internet traffic increases the target market size for F5′s product portfolio.
The company 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. 
It 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 intended to add another 100 employees in Q2 2013. 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.
Increasing Presence In Key Markets – Security and Mobile Application Delivery
With the explosion of data and processing required online, security has become a major concern for most enterprises, 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, which witnessed strong growth in Q1 2013.
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. 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.
Keeping it well in line with changing trends and developments, we expect F5’s increasing focus on security and mobile applications to make its product portfolio more competitive.
We will update our price estimate of $130 for F5 Networks after the earning release.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 [↩]