Juniper (NYSE:JNPR) announced a solid set of Q3 results on October 22nd, as revenues grew by 6% over the same period last year and operating margins expanded to the highest levels in almost two years. While enterprise spending remained weak, the service provider market continued to recover well from the macroeconomic overhang of the Euro debt crisis. Juniper’s service provider revenues grew almost 12% y-o-y, more than offsetting the 4% decline in the enterprise segment. The service provider outperformance was led by gains in routing, as Juniper’s newly launched MX line of edge routers drove 22% y-o-y growth in routing revenues. Along with revenue gains, Juniper continued to benefit from its ongoing restructuring drive, which drove efficiency in operations and helped margins grow to almost 20% compared to less than 17% a year ago.
However, Juniper’s stock fell 2.35% in after-hours trading Tuesday as the company disappointed with its Q4 guidance. Juniper expressed concerns about the recent government shutdown in the U.S., which it expects to have an adverse impact on federal spending next quarter. Government revenues, however, account for only about 4.5% of Juniper’s business, so any long-term impact from federal weakness is likely to be limited. On the other hand, the overall strengthening of the networking market is a big positive for the company, whose new products have been gaining momentum in the more important service provider market – which accounts for about 65% of its total revenues. Juniper’s new products generated about $110 million in revenues in Q3, putting it on track to achieving a quarterly revenue run-rate target of $150 million by the year-end. Our $23.50 price target for Juniper is about 17% ahead of the current market price.
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Growth In Data Demand Despite Weak Macro
With macroeconomic uncertainty subsiding, service providers have started investing more heavily in their network infrastructure. The recent macroeconomic concerns had caused project cycles to lengthen and extended the delivery timelines from customers. Capital spending on networks – and hence Juniper’s revenues – should therefore continue to extend recent gains as economic conditions stabilize. This is because the macro concerns have had little impact on data demand, which has remained strong driven by the key trends of mobile Internet and cloud computing. Specifically, mobile data traffic has grown exponentially with the proliferation of mobile devices such as smartphones, e-readers and tablets. According to a recent Cisco VNI report, mobile data traffic grew 70% in 2012 and is expected to grow at a CAGR of about 65% over the next five years. ((Global Mobile Data Traffic Forecast Update, 2012–2017, Cisco, February 6th, 2013))
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. In the U.S., where service provider demand is on the rise, Verizon and AT&T are big Juniper customers with each accounting for about 10% of Juniper’s revenues. The performance of Juniper’s new MX series of edge routers this quarter is perhaps the most encouraging, given that the edge router market is by far the biggest among all router markets. By our estimates, edge routers account for more than 50% of the overall market and about 70% of the service provider router market. Market share gains in edge routers should therefore be the most accretive to Juniper’s value in routers, which accounts for almost 40% of its overall valuation by our estimates.
Disciplined Growth In Operating Margins
Apart from the revenue gains, Juniper is also managing expenses well to improve margins. The September quarter’s Non-GAAP operating margins were up almost 300 basis points y-o-y, to about 20%. The guidance for Q3 is also a strong 22%, an improvement of about 400 basis points over the same period last year. A big portion of the rising operating margins is coming from its services division, where the company has been driving greater efficiency in customer support and service delivery. The ongoing restructuring, which will see an additional 280 job cuts in Q4, will also result in cost savings of about $150 million for the full year 2013, as compared to 2012. At the same time, Juniper is seeing increased traction for its new products, especially in routing that should help it defend its product gross margins going forward.
However, the effect is likely to be gradual since new products generally need time in the market to start having a meaningful impact. Still, the initial signs are good, with the new products such as P4000, PTX and QFabric already accounting for more than 12% of its product revenues last quarter. Juniper is also confident of achieving a quarterly revenue run rate of $150 million for the new products by the end of the year, when they could account for almost 20% of total revenues by our estimates.