A year and a half ago, Juniper Networks (NYSE:JNPR) was trading at over $40 levels with the stock touching a 10-year high of $44 in March 2011. The overall improvement in economic conditions had caused carriers and enterprises to spend heavily on network infrastructure and Juniper’s earnings received a boost as a result.
However, concerns over economic growth have resurfaced since then as the sovereign debt crisis emerged in Europe and debt levels in the U.S. touched alarming levels. Consequently, Juniper’s shares have taken a beating and are currently trading at their lowest in more than three years. And, with the management being cautious in its guidance and announcing job cuts as well, valuations could remain depressed in the near term. Juniper’s competitor Alcatel-Lucent (NYSE:ALU) has also slumped in the wake of concerns over the macro environment. However, the networking market leader Cisco (NASDAQ:CSCO) is doing slightly better than its competitors.
Despite the macro-economic uncertainty, we are positive about Juniper’s long-term outlook, and see more value coming from new product launches and long-term data growth trends. We maintain our price estimate of $26, which is around 55% ahead of the current market price.
Revenue growth has slowed down, but not for long
As the macro environment remains challenging, we expect Juniper’s customers to remain cautious on capital spending. While Juniper’s revenue improved sequentially last quarter, it registered a decline of 4% year-over-year. The company’s guidance for the next quarter, at the mid-point, also implies a similar decline over the same period last year. While the outlook over the next few quarters will continue to remain challenging, we see this as a near-term phenomenon since the ongoing economic concerns have only resulted in longer project cycles and extended delivery timelines from customers. This implies that revenues will go up again as the economic conditions stabilize.
Besides, since the broader market continues to be strong driven by two key trends of mobile Internet and cloud computing, we can expect higher demand for Juniper’s products and services as mobile devices such as smartphones, e-readers and tablets proliferate. Mobile data traffic grew 133% in 2011 and is expected to grow at a CAGR of close to 80% over the next five years, according to a Cisco VNI report.  Service providers, who will need to buy networking gear to support the burgeoning demand for data, account for almost two-thirds of Juniper’s revenue, with some of the largest U.S. wireless carriers such as Verizon contributing almost 12%, as of Q2 2012.
New products drive Juniper’s value
As a consequence of declining revenues, Juniper has had to take a margin hit due to high fixed costs for its innovation business. The operating expenses increased in 2011 even as revenues dropped due to the high levels of R&D investment that the company maintained throughout the year. The R&D expenses so far this year have shown no signs of slowing down. While operating margins for the last quarter improved sequentially due to lower G&A expense, it showed a y-o-y decline of 7% as R&D expenses continued to mount.
Thanks to that investment, however, Juniper has an extended products and solutions portfolio in 2012 that can help it cater better to the fast-changing marketplace and tide over the ongoing economic concerns. The positive impact could be seen in the last quarter’s small revenue guidance beat, but the effect will be even greater when the global economic conditions improve.
We expect the operating expenses to remain high, going forward, as Juniper continues to invest in R&D to come up with new versions of its core router and switching products such as the T4000 and PTX launched last year, which have so far done well to win clients in a fast-changing environment.
Juniper’s product gross margins have been declining for quite some time. Last year, margins declined by more than 2% to about 67% in 2011. This was due to relatively lower volumes for its routing business, which accounts for more than 35% of its value by our estimates. A higher routing mix supported by new product launches has since resulted in product margins improving sequentially in Q1 2012 and remaining nearly flat in Q2.
We expect the new routing products will continue to improve the firm’s overall product mix toward higher-margin routing products, providing support for its declining product gross margins as a result. This impact would however be gradual since new products generally need time in the market to start having a meaningful impact.Notes:
- Global Mobile Data Traffic Forecast Update, 2011–2016, Cisco, February 14th, 2012 [↩]