New Products Can Reaccelerate F5’s Growth Momentum

One of the leading providers of technology solutions optimizing the delivery of network-based applications, F5 Networks (NASDAQ:FFIV), is set to announce its Q3 2013 earnings on July 24. It closed its fiscal 2012 with $1.38 billion in revenues marking 20% growth over 2011, and posted its 15th consecutive quarter of revenue growth in Q1 2013. However, a difficult macro environment led to a sharp decline in earnings from telecommunication customers and the U.S. federal government, which in turn lowered F5’s revenue by 4% (q-o-q) in Q2 2013.

Though macro headwinds could continue to impact F5’s top line growth in the short-term, we believe that the company has strong fundamentals to continue expanding its business in the long run. Despite a slowdown in its growth rate, F5 has consistent operating margins, a solid balance sheet with strong cash generation and no debt.

Believing that its competitiveness in the market remains intact, F5 remains committed to re-accelerating its product revenue growth in the future. It completed its most significant product refresh in several years, last month. We believe that the upgraded product portfolio aided by an expanding salesforce can help re-accelerate F5’s product demand, as the economic situation stabilizes.

See our complete analysis for F5 Networks here

New Products To Spur Future Demand

While F5 had a strong pipeline of deals at the start of Q1 2013, it experienced difficulty in closing certain deals as customers hesitated to release purchase orders. In addition to macro uncertainty which led to budget constraints, F5 believes that its customers delayed their project timeline and prolonged decision making in order to transition to its new range of products.

For the last few quarters, F5 has been focusing on what it claims to be the most significant product refresh in several years. It developed a range of new products and software solutions planned for launch in 2013, with which it aims to boost demand and create new revenue growth opportunities for the future. The product upgrade was concluded in Q3 2013 and F5 claims that the products are gaining traction in the market.

The new products offer significant price performance advantages which we believe will increase the company’s growth opportunities in key markets including security, service providers, cloud-based architectures and new-generation data centers.

F5′s entry in the Internet firewall market is another factor which we believe will increase its competitiveness in the market. 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. The company recorded strong sales of its application security module (ASM) and advanced firewall manager (AFM) in Q2 2013. It started shipping AFM in mid-February and its solutions were purchased by over 50 customers. ^[1] AFM is the world’s fastest and most scalable application delivery firewall solution.

F5 To Gain From Cisco’s Exit From The ADC Market

Last year, rival firm Cisco announced its decision to exit the ADC market after losing more than 50% of its market share to F5 and Citrix. F5 is the market leader in ADC and the segment accounts for close to 60% of its total product revenues. In its last earnings call transcript, F5 declared that it has scored big product wins by replacing some of Cisco ACE products in large customer accounts and has a strong pipeline of similar opportunities. In addition to replacing Cisco’s existing solutions, F5 has the added opportunity of providing customers additional functionality like DDoS prevention and application security solutions.

Though Citrix remains a big threat for F5, we believe the latter will continue to retain its dominance in the ADC market. (For a detailed discussion read our article: F5 Gains As Cisco Exits The ADC Market)

Rising Competition Could Restrict Margin Growth

F5′s faces increasing competition in the application delivery networking market. In addition to some of the larger players like Cisco, Juniper and Citrix, it also competes against new entrants such as Palo Alto Networks, Fortinet and Sourcefire. Cisco and Juniper are two of the biggest networking hardware companies in the world and are known for selling more conservative products such as routers and switches.

Though it continues to dominate the ADC market, F5′s market share in the segment declined from 58.1% in 2011 to 55.6% in 2012, while that of its closest competitor Citrix increased from 17.3% to 19% during the same period. ((Is F5 Networks’ Fumble a Buying opportunity?, The Motley Fool, April 10, 2013)) F5 is facing competitive pressure from potentially lower cost software based solutions from Citrix. Falling ADC prices over the years have attracted small and medium sized businesses as well as large enterprises and service providers, driving growth in the market. In order to face Citrix’s growing threat and retain its leadership in ADCs, F5 might have to lower its prices to spur demand which can put pressure on margins.

Historically, F5 has enjoyed very high gross margins and a potential decline in the same can significantly impact its valuation.

We will update our price estimate of $114 for F5 Networks after the Q3 2013 earnings release.

Understand How a Company’s Products Impact its Stock Price at Trefis

1. F5 Networks Management Discusses Q2 2013 Results – Earnings Call Transcript, Seeking Alpha, April 24, 2013 [↩]