Why We Believe F5 Networks Is Worth $127

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FFIV: F5 logo
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F5

F5 Networks’ (NASDAQ:FFIV) stock has fallen 20% over the past 12 months. We believe that a lower revenue guidance for the forthcoming quarter, rising competition in the Application Delivery Controller (ADC) market and a volatile spending environment have contributed to the negative sentiment around F5′s stock. However, this should not be a major concern for F5 as the company usually sees a seasonal softness in the first quarter followed by better results in the subsequent quarters. On the competitive front, F5 can defend its market share by launching cutting-edge products and staying in line with emerging trends in the market. In fact, F5 has successfully managed to leverage growth in the ADC market in the past on the back of rising Internet traffic, data-center build-outs and the increasing shift to cloud-based services and storage.

Our price estimate of $126 for F5 Networks is at a significant premium to the current market price of $96. Below we discuss the reasons why we believe that F5 has a strong growth potential:

See our complete analysis for F5 Networks here

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Strong Leadership In Application Delivery Controllers (ADCs)

The Application Delivery Controller (ADC) is an important tool for managing data network traffic. Growing network traffic, a shift to cloud-based services and data center virtualization are some of the factors driving demand for ADCs. F5 derives a significant portion of its revenue from ADCs, and has been the leader in the segment for many years. The company had a massive 52%  share of the ADC market in 2014. A recent report published by research firm Gartner placed F5 Networks at the top of the Leaders Quadrant for Application Delivery Controllers (ADC) for the ninth consecutive year. The same report regarded the company highest in execution and furthest in vision within the quadrant.

However, F5 may not enjoy significant gains in the ADC market, owing to the competitive threat from its rival, Citrix. With a software based solution, Citrix is a leading player in virtualization offerings, which is a fast growing sub-segment of ADC. The company has even partnered with Cisco in various areas of data-center and virtual desktop infrastructure, which poses a serious challenge for F5. Moreover, F5 was recently downgraded by Guggenheim, with the firm stating that the company’s core ADC business is slowing and it has become a net ADC share donor. A recent Gartner’s market share data shows that F5 lost 130 basis points of revenue share from Q1’15 to Q2’15, and 60 basis points from Q2’14 to Q2’15. [1]

Nevertheless, F5 has been the leader in ADCs for many years and has the expertise, resources and capital to defend its leadership in the market for years to come. Although F5 Networks might not be able to increase its ADC market share at the historic rate, but we still believe that its ADC segment will continue to grow.

Strong Focus On Applications And Feature-Rich Products

F5’s investment in iRules and iControl help realize new levels of automation and configuration management efficiency in the network, resulting in a loyal customer base that would find it difficult to migrate away from F5. Integration with popular integrated development environments (IDEs) such as Eclipse and .NET/Visual Basic also contributes to increased customer stickiness as these features provide an easy way to control and configure the services on F5’s BIG-IP platforms. Ease of configuration reduces the complexity of the systems.

Increasing Sophisticated Cyber Crimes To Benefit F5

Reducing security risk is an important criterion for enterprises with an ever increasing network complexity. Over the years, data theft technology has become more sophisticated and the global cyber-crime market is currently sized at $75 billion. F5 can see strong demand for its expanding portfolio of security solutions as customers look to secure their applications from cyber crime.

F5 claims that, given the highly visible cyber security attacks in Q3 2015, more customers from an increasing diverse pool were approaching the company to tap its ability to secure applications, manage user policy and access, and mitigate application attacks across traditional networks. As a result, F5 had a number of notable wins in Q3 2015, including a branch of the U.S. government and a prestigious medical research group, both of which needed to secure their organization’s remote access capabilities. Additionally, a multi-national defense contract to purchase its Access Policy Manager for single sign-on federation and three national carriers came to F5 for a variety of security solutions. In Q3 2015, F5 signed its largest service provider security deal to-date, a multi-million dollar agreement with a domestic tier 1 carrier.

F5 Has Strong Financials

F5 almost tripled its revenue base in the last five years, from a little over $500 million in 2009 to approximately $1.5 billion in 2014. Despite having a strong growth potential, high gross margins of nearly 80% and no debt, the company is trading at a P/E ratio of 19, which is significantly low as compared to its rival – Citrix’s P/E ratio of 42. Therefore, F5 looks attractive at its current valuations. Furthermore, F5 continues to invest in key areas of technology (such as security, mobility, the cloud, and software-defined application services) to defend its Application Delivery Network (ADN) market share. F5 underwent the most significant product refresh in several years in 2014, with the aim to boost demand and create new revenue growth opportunities for the future. With the aforementioned factors in mind, F5’s financial position also looks promising.

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Notes:
  1. F5: Guggenheim Cuts to Hold; Surrendering Share in Apps Controller Market, Barron’s, September 22, 2015 []