How the Application Delivery Network Segment Could Lead To A Significant Upside For F5 Networks?

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F5 Networks (NASDAQ:FFIV) is a provider of application delivery products and services with a broad portfolio including network data and signalling traffic management. The company faced criticism for lowering its 2015 fiscal outlook, due to a larger than expected drop in million dollar plus deals in both large enterprise and Federal sectors in the U.S. in Q1 2015. However, F5 claims to have seen a rebound in such large deals in Q2 2015.

F5 continues to be a market leader in ADCs with a 52% market share. The company believes that its security business will be the largest growth driver, and expects to see strong demand for its expanding portfolio of security solutions as customers look to adopt hybrid architectures, deploying applications both in premise and in the cloud. It believes that its existing product portfolio, its hybrid application services, strategy, and its future product roadmap are a key to enabling in-line customer and market trends.

Our price estimate of $128 for F5 Networks is almost in line with the current market price. Below are two key factors that can significantly increase the company’s valuation.

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See our complete analysis for F5 Networks here

Global Application Delivery Network (ADN) Market Increases To $8 billion (~15% Upside)

Cyber-based threats are being recognized as constituting a top economic risk. In a 2012 World Economic Forum risk report, cyber-attacks ranked as the 4th most likely risk faced, and in the 2013 edition cyber-attacks, data fraud/theft and digital misinformation were noted as possible contributors to ‘digital wildfires’ in a hyper-connected world. The potential reach of cyber-crime is vast — including much of the global economy. 70% of households and 94% of businesses with 10 or more employees are online. There is a growing demand for applications and content as subscribers now interact with different types of networks and protocols. Additionally, newer, feature-rich mobile devices require more connections and bandwidth per user. [1]

With increasing network complexity, reducing security risk is an important criterion for enterprises. The cyber security market is estimated to grow from $95.60 billion in 2014 to $155.74 billion by 2019, increasing at a CAGR of 10.3% from 2014 to 2019. [2] Owing to the growing awareness of its security solutions in the market and tech-savvy customers, F5 believes that security segment offers huge growth opportunity and expects the strong sales momentum to continue in the coming quarters as well.

The software ADC market is growing rapidly, supported by the introduction of Software Defined Networking. A software ADC is an ADC without dedicated physical hardware, which allows network administrators to leverage existing software-enabled, for example, via a Virtual Private Network. The combination of more data, increasing internet access, and mobile users is causing problems for network administrators. With Software Defined Networking, a software management payer is added to better manage the underlying network hardware. Transparency Market Research estimates the SDN market to cross $3.5 billion by 2018. [3]

We currently forecast the global ADN market to increase from $3.7 billion in 2014 to $6.9 billion by the end of our review period. However, as a result of strong growth owing to increasing cyber crime market, F5 could gain revenue at a much faster pace.  If F5’s market increases to $8 billion, and it maintains market shaer, it will lead to a 15% increase in our valuation for the company.

F5’s Market Share In ADN Segment Increases To 35% (~10% Upside)

F5 continues to see strong growth in its ADN segment on account of an expanding security business and increasing acceptance of its ‘Good,Better,Best’ pricing structure. The company saw double-digit growth in the service provider segment, and deferred revenue rose 23%. F5 announced that it won a large scale AFM Gi firewall project in a Tier 1 service provider in North America. This will be significant not only in growing the company’s revenue out through next year, but will also give the company an opportunity to cross-sell products like its Traffix diameter signalling solutions.  Overall, it continues to look as though the company’s attempt to drive greater attachment of security products to its core ADC products is going well.  F5 has long dominated the physical ADC market (roughly 50%), and we believe that it is unlikely that its rivals are going to seriously disrupt its position in the market. According to the research firm, TechNavio, the global ADC market will grow at a CAGR of 8.1% between 2013 and 2018.

F5 can gain from the troubles of its rivals such as Cisco and Juniper. F5 sees a good opportunity in the aging installed base of Cisco’s application control engine modules and has recorded a good number of project wins. F5’s prospects are helped by the fact that customers are now looking to include additional functionality, such as security access control and application acceleration, as security is becoming an important aspect. Although Cisco beefed up its security business by acquiring SourceFire last year, it hasn’t completed the integration, yet. F5 already specializes in this field, and as a result, it could gain more business  against Cisco. Additionally, given that even Juniper’s products were found susceptible to Heartbleed ( a security bug), F5 could use this fact to its advantage. Juniper has a very large install base in carrier security, and F5 is trying to make its mark in this space. However, Heartbleed has affected several routers, switches, and security firewalls sold by Juniper. The company has tried to address this issue by providing a patch, but flaws like these can loosen Juniper’s grip in the security market and give F5 room to expand. [4]

With a history of successful acquisitions, F5 may look at future acquisitions as a source of new growth opportunities. In many cases, this would involve broadening the scope of its offerings and expanding into adjacent markets. Any acquisition done by F5 could be a threat to its competitors as more consolidation in the industry will lead to attracting focused customers. F5 also has a history of successful international expansion, which should allow it to build revenue globally, and especially as emerging markets quickly grow their technology sectors.

We currently forecast F5’s ADN market share to increase marginally, from 25.3% in 2014 to 25.9% by the end of our review period. However, as a result of strong growth coming from the securities business segment and the potential gain of new customers (owing to its rivals’ troubles), F5 could gain market share at a much faster pace.  If F5’s market share increases to 35%, it will lead to a 10% increase in our valuation for the company.

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F5 continues to be a market leader in ADCs.
Notes:
  1. Cyber-crime, securities markets and systemic risk, WFE, Page 9, July, 2013 []
  2. Cyber Security Market worth []
  3. F5 To Remain The Leader In The ADC Market, Forbes, September 11th, 2014 []
  4. HeartbleedFound in Cisco, Juniper Networking Products, Bloomberg, April 11th, 2014 []