F5 Networks Earnings Preview: Seasonal Softness To Affect Q1 Revenues, But Growth Prospects Strong In 2016

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F5 Networks (NASDAQ:FFIV) is set to report its Q1 2016 earnings on January 20th. (Fiscal years end with September.) The company expects to see a sequential decline in revenues due to seasonal softness in Q1. F5’s profitability can be further impacted by foreign currency fluctuations in Latin America and lingering macroeconomic issues in parts of Europe and Canada. Although the Q1 results was likely subdued,  the outlook for the full year is solid, driven by its big IP releases and security offering, as well as sales and channel productivity gains. In addition, it sees gains from an acceleration of  cloud and Silverline sales, as well as new software and a hardware upgrades in the second half of the year. The company expects its Q1 revenues in the range of $480 to $490 million, reflecting a sequential decline of approximately 4% and a year-over-year increase at the midpoint of 5%.

Our price estimate of $127 for F5 Networks is approximately 25% above the current market price.

Currency Fluctuations, Macroeconomic Issues And Market Transitions Affecting F5’s Growth Rate

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Macroeconomic factors and the strengthening of the U.S. dollar have lowered demand for the company’s products, espcially in Central and South America.   Additionally, the recent Fed rate hike and weakening economic growth in Europe and China have further hindered demand.  F5 also experienced slowed growth momentum in 2015, owing to a pause in the ADN (Application Delivery Networks) market due to network transitions. Moreover, future drivers of strong growth have yet to be adopted, thus limiting demand.  These include the Hybrid Cloud, SDN (Software Defined Networking), and NFV (Network Function Virtualization). All of these factors will continue to impact F5’s profitability in the coming quarters as well.

Security Business And Cisco Ace Replacement Opportunity To Drive Growth For F5 In 2016

Reducing security risk is imperative 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. In the coming quarters, F5 can see growth coming in from the rising demand for its expanding portfolio of security solutions as customers look to secure their applications from cyber-crime.

Other drivers for the year ahead include access control and application acceleration, features that are attractive to enterprises IT managers.  F5 also has the added opportunity of replacing Cisco’s existing solutions. In 2012, 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 has scored big product wins by replacing some of Cisco ACE products in large customer accounts since then. In Q4 2015, the company won a competitive $1 million ACE replacement order at a Fortune 100 company. [1] F5 continues to see opportunities in Cisco ACE replacement in fiscal 2016. The ACE installed base is over $1 billion of potential business, but F5′s target market is much larger.

F5 Can Leverage Its Strong Leadership Position In ADC Market

The Application Delivery Controller (ADC) is a key system within enterprise and cloud data centers that improves the availability, security and performance of applications across networks. Essentially, an ADC distributes workloads throughout a computer network, simplifying both the management of data centers and the delivery of resources across diverse networks. F5 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 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, which is a fast growing sub-segment of ADC market. 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 F5’s leadership position in the market will provide the company an edge over its competitors in the ADC segment.

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Notes:
  1. Q4 Earnings Transcript, Seeking Alpha, October 2016 []