Having spent most of 2012 in the shadow of bigger rival Cisco (NASDAQ:CSCO) as macro-economic concerns took a toll on network spending, Juniper Networks’ (NYSE:JNPR) stock remained subdued for a greater part of last year. However, going into 2013, Juniper seems to have weathered the sluggish environment for the most part as its new products have been gradually gaining traction in the marketplace. The company managed to gain router market share in Q3 2012, regaining the second position behind Cisco, and pushing Huawei down to fourth place in the router market. This helped Juniper post better than expected results in Q3, as the company beat its revenue guidance on the high-end by 4%. In addition, the company has announced job cuts that will result in cost savings of roughly $150 million annually.
However, the overall networking market isn’t out of the doldrums just yet. According to Infonetics Research, service provider spending on networking gear in Q3 2012 dropped 5% over the same period last year, as a result of the ongoing macro-economic uncertainty surrounding the European debt crisis. In addition to Juniper, concerns over the macro environment are taking a toll on competitors Alcatel-Lucent (NYSE:ALU) and Cisco as well, with the latter doing slightly better than the rest. However, we are positive about Juniper’s outlook as the long term trends of data growth and mobility remain strong, which the company should be able to capitalize on as its new products gain more momentum. Juniper’s stock has rallied almost 20% in the last two months and is now trading at $20 levels. We maintain our $25 price estimate for Juniper, about 25% ahead of the current market price.
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Revenue Growth Has Slowed Down, But Not For Long
With macro-economic uncertainty likely to persist in the near term, we expect Juniper’s customers to continue to be cautious with their capital spending. While the company managed to grow its Q3 revenues by 4% sequentially, its guidance for Q4 implies a roughly flat quarter y-o-y at the midpoint. Juniper is not alone in giving subdued guidance. Even Cisco continues to maintain a conservative stance while setting quarterly expectations, implying a challenging industry outlook over the next few quarters. However, we see this as only a near term phenomenon since the ongoing economic concerns have only resulted in longer project cycles and extended delivery timelines from customers. Network spending and hence, Juniper’s revenues, should once again grow as economic conditions stabilize.
Additionally, since the broader market continues to be strong driven by the key trends of mobile Internet and cloud computing, we 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 recent 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 as much as 12% as of Q2 2012. AT&T, also one of Juniper’s bigger customers, has increased its CapEx guidance by $14 billion over the next four years.
New Products Drive Juniper’s Value
As a consequence of the slump in revenue growth, Juniper has had to take a margin hit due to high fixed costs for its innovation business. Its 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. This year as well, the R&D expenses have shown no signs of slowing down. While operating margins for Q3 improved sequentially due to higher gross margins, it showed a y-o-y decline of over 300 basis points as R&D expenses continued to mount.
Thanks to that investment, Juniper had an extended products and solutions portfolio in 2012, that could 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 company’s 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. The T4000 and PTX core routers launched in 2011 have done well so far, and the new line of MX edge routers as well as the ACX Universal Access product family should help it continue to win clients, in a fast-changing environment. Meanwhile, Juniper expects that its focus on streamlining operations by cutting jobs will bring about operating cost savings of about $150 million annually.
Juniper’s product gross margins have been declining for quite some time. In 2011, margins had declined by more than 2% to about 67%. This was due to relatively lower volumes for its routing business, which accounts for almost 35% of its value by our estimates. A higher margin routing mix supported by new product launches, has since resulted in product margins improving sequentially every quarter in 2012 so far.
We expect the new routing products to 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. However, this impact would 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 [↩]