Juniper Networks’ (NYSE:JNPR) new router products seem to be doing well in a sluggish networking market. The company regained the second position behind Cisco in the router market, pushing Huawei down to fourth place in Q3 2012, according to a recent market report by Infonetics Research. This is reflective of Juniper’s recently announced Q3 results, which came in better than expected as the company beat its revenue guidance on the high-end by 4%. What was most encouraging about the Q3 data was that Juniper managed to achieve this despite a 5% drop in the overall service provider market due to the ongoing Eurozone debt crisis. This was driven primarily by Juniper’s good showing in China and EMEA as well as an increased adoption of its new routing products such as PTX and T4000.
However, the networking vendor offered subdued guidance for Q4 citing near-term macro-economic uncertainty surrounding the European debt crisis. Concerns over the macro environment are also taking a toll on competitors Alcatel-Lucent (NYSE:ALU) and Cisco (NASDAQ:CSCO), with the latter doing slightly better than the rest. However, we are positive about the company’s outlook as the long-term trends of data growth and mobility remain strong, which Juniper should be able to capitalize on as its new products gradually gain more momentum. We maintain our price estimate for Juniper to $25, about 40% ahead of the current market price.
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Revenue growth has slowed down, but not for long
With macroeconomic 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.
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, 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 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 last year have done well so far, and the new line of MX edge routers as well as the ACX Universal Access product family (to be launched in Q4) should help it continue 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 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. 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 [↩]