Juniper Earnings Preview: Edge Router Sales, Cost Savings In Focus

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Juniper Networks

Juniper (NYSE:JNPR) is scheduled to announce its Q3 2014 results on Thursday, October 23. The company reported a strong set of results in the previous quarter, with sales growing 7% year-over-year (y-o-y) to $1.23 billion, matching the upper end of its guidance. However, a lower-than-expected outlook for the third quarter brought the stock down by about 10% in intraday trading when it released second quarter earnings on July 23. The company’s stock witnessed another steep fall last week when it issued preliminary Q3 financial results, which stated that it was likely to miss its already lowered revenue guidance of $1.15-$1.20 billion on account of sluggish demand from service providers in the U.S., and the expected revenue for the third quarter now stands at $1.11-$1.12 billion. ((Press Release, Juniper, Oct  9, 2014))

The negative sales revisions have raised a lot of questions on Juniper’s business strategy and sustainability. This is because more than two-thirds of Juniper’s overall revenues come from service providers, and any sluggishness in demand significantly impacts the company’s top line as well as bottom line. The router business, accounting for about 50% of Juniper’s sales and 40% of its value according to our estimates, is currently in a transitional phase as it competes against white boxes as well as software-run virtual systems. We believe improved router sales will be key to the company’s revival, and it will be interesting to see whether switching sales can sustain their double-digit sales growth in the near term.

Our $28 price estimate for Juniper is currently significantly ahead of the market price, and we will revise our pricing model following the earnings release. 

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See our full analysis of Juniper Networks

Weak Edge Routers Sales Growth Expected

Service providers account for more than two-thirds of Juniper’s revenues. In the U.S., 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 has been the most encouraging, given that the edge router market is by far the biggest among all router markets. However, with the company reporting weak demand in the past few months, we expect the company to report sluggish growth in edge router sales in the third quarter.

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 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% y-o-y in 2013 and 2012, respectively. Juniper’s switching sales grew by an impressive 25% y-o-y to about $200 million in the second quarter, driven by sustained strong demand for QFabric products. 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 (NASDAQ:CSCO). [1]

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. [2] 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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Notes:
  1. Cisco maintains 62.2 percent market share in Ethernet switch market, Fierce telecom, Aug 2013 []
  2. Elliott Management’s Perspectives on Juniper, January 13th, 2014 []