Juniper Earnings Preview: Edge Routers, Enterprise Switches, Cost-Cutting Initiatives In Focus

Juniper (NYSE:JNPR) is expected to announce its Q2 2014 results on Tuesday, July 22. The networking company has done well in recent quarters, growing its revenues and operating margins on increased demand for enterprise switches and edge routers. Last quarter, Juniper’s total revenues increased over 10% year-over-year to $1.17 billion, driven by solid growth in enterprise revenues and a continued recovery in the service provider market. The enterprise business was led by gains in switching, as strong adoption of EX and QFabric saw switching revenues jump by a huge 46% over the same period last year. On the service provider side, Juniper’s newly launched MX line of edge routers continued to do well, offsetting weakness in the core due to the usual lumpiness in order bookings. ^[1]

In its second quarter results, we expect the company’s sales to grow in mid-single digits on account of sustained demand in switches and routers. In routers, the industry is spending primarily on the edge and metro segments rather than the core, and this should help the company’s MX line of edge routers to continue to perform well, offsetting the weakness in the core segment. The company is also in the process of cutting costs and streamlining its business as part of its “Integrated Operating Plan (IOP)”, which it launched in February. It expects to incur certain restructuring expenses every quarter for the rest of this year, which is likely to impact profitability in the near term, but recurring cash savings should drive long term value in the stock. Our$28 price estimate for Juniper is about 15% ahead of the current market price.

See our full analysis of Juniper Networks

Edge Routers Key To Growth

Service providers account for more than two-thirds of Juniper’s revenues. In the U.S., where service provider demand is on the rise, Verizon and AT&T have been big Juniper customers, with each accounting for about 10% of Juniper’s revenues in recent years. The performance of Juniper’s new MX series of edge routers in recent quarters 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. There is still some lumpiness being seen in the order build-up for core routers, but Juniper managed to more than offset that with MX’s continued strength in the edge last quarter. Routers account for over 40% of Juniper’s overall valuation by our estimates, and market share gains in edge routers should be the most accretive to Juniper’s value going forward.

WLAN Business Expansion Likely To Boost Switching Sales

The Wireless LAN (WLAN) business is included in the company’s Switching division, which contributes over 15% of its valuation according to our estimates. Juniper’s switching business has performed impressively in the last few years, with sales increasing 15% and 12% year-over-year in 2013 and 2012, respectively. In the first quarter this year, sales grew by a whopping 46% over the prior year quarter driven by new product launches in the EX line of ethernet switches and strong demand for QFabric products. ^[2] Going forward, the introduction of new products and its ability to promote the open converged framework (OCF) concept could help Juniper gain share in the global switching market, which is currently dominated by Cisco. ^[3]

Juniper recently entered into a strategic agreement with WLAN provider Aruba Networks (NASDAQ:ARUN) to deliver integrated wired and wireless network solutions. Although Aruba will be the expert Wi-Fi provider in this newly formed partnership, Juniper’s WLAN business could also get a boost as the company integrates the business with its other offerings such as enterprise security and intelligent routing solutions. If the company can expand its market share from an estimated 3.2% in 2013 to about 6% by 2020, we could see a potential upside of about 7% to our price estimate for its stock.

Restructuring To Improve Cash Flows By $100 Million

Juniper has historically been an innovation-focused company, relying heavily on an expensive R&D budget to out-innovate rivals and gain market share. Its R&D costs as a percentage of revenues have generally been among the highest in the industry. Juniper’s R&D spend as a percentage of revenues of about 21-22% is about 9 percentage points higher than peers such as Cisco and F5 networks. ^[4] Reducing this to peer-average levels of 11-12% could drive cost savings of about $420 million in the longer run. Juniper’s plan to cut expenses by $160 million on the back of the ongoing restructuring initiatives is about 40% of that, and can be reasonably expected to be achieved in the near term.

If Juniper realizes the planned cost savings by 2015, we expect its OpEx as a percentage of gross profits to decrease from around 63% in 2013 to about 54% two years out. Consequently, its EBITDA margins would improve by almost 540 basis points (5.4%). Adjusted for taxes, this could lead to an improvement of more than $100 million in free cash flow going forward. Our current estimates assume that the company will be able to implement its planned initiatives successfully and realize the aforementioned increase in cash flows as a result.

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1. Press Release, Juniper, April 22 2014 [↩]
2. Juniper Q1 2014 10-Q [↩]
3. Cisco maintains 62.2 percent market share in Ethernet switch market, Fierce telecom, Aug 2013 [↩]
4. Elliott Management’s Perspectives on Juniper, January 13th, 2014 [↩]