Juniper (NYSE:JNPR) announced a strong set of Q4 results on January 23rd, as revenues beat the high end of guidance by almost 4% and operating margins expanded to the highest level in almost two years. While the service provider market continued to recover well from the macroeconomic overhang of the Euro debt crisis, enterprise spending did surprisingly well despite fears about federal weakness. While Juniper’s service provider revenues grew almost 12% year-over-year, the enterprise segment nearly matched it with 11% growth over the same period last year. The service provider outperformance was led by gains in routing, as Juniper’s newly launched MX line of edge routers and the PTX supercore drove a 17% y-o-y growth in routing revenues and a 30% increase in order bookings. The EX and QFabric data-center switches also saw strong adoption, as switching revenues jumped by 36% over the same period last year.
Along with revenue gains, Juniper continued to benefit from its restructuring efforts, which drove efficiency in operations and helped margins grow to almost 22%, compared to 18.2% a year ago. The company also confirmed that it is preparing an “integrated operating plan” to streamline R&D costs and drive long-term value, and the plan will be unveiled to investors in the next few weeks. Last week, activist shareholder Elliott Management announced that it has acquired a 6.2% stake in the company and pushed management to consider cost cuts, dividend payouts and stock buybacks to increase shareholder returns. Although Juniper did not give any specifics about the plan, we have reduced our R&D cost estimates by about $200 million from 2015 onward in accordance with our belief that the company will implement a plan not very different from what Elliott has suggested. Our revised $27.35 price estimate for Juniper is about in line with the current market price.
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Data Growth Continues Despite Lingering Macro Concerns
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 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. Market share gains in edge routers should therefore be the most accretive to Juniper’s value in terms of routers, which account for almost 40% of its overall valuation by our estimates.
R&D Cost Streamlining To Drive Cash Flow Gains
Juniper has historically been an innovation-focused company, relying heavily on an expensive R&D budget to out-innovate rivals and gain market share. Even in recent years when macroeconomic uncertainties caused the networking market to stagnate and Juniper’s revenue growth to slow, the company continued to invest aggressively in R&D and create new product lines. Historically therefore, Juniper’s R&D costs as a percentage of revenues have generally been one of the highest in the industry. Compared to peers such as Cisco and F5 networks, Juniper’s R&D spend as a percentage of revenues of about 21-22% is 9 percentage points higher. Reducing this to peer average levels of 11-12% could drive cost savings of about $420 million. Elliott estimates that about half of this, or about $200 million in operating cost savings, can be reasonably achieved in the near term.
Most of these cost savings could come from scaling back efforts to develop new product lines in switches and reducing R&D expenses in underperforming businesses such as security. The company hasn’t done well in the switches market, where it faces tough competition from big entrenched enterprise players such as Cisco. As a result, despite entering the switching market almost six years ago, it has managed to grab a share of only 3%, and we don’t expect this to grow meaningfully going forward as well. Juniper has also been losing market share in network security, where its revenues have declined by almost 25% over the past 3-4 years. According to IDC, Juniper’s market share in the security appliance market has declined from 14% in 2003 to 6% in the first three quarters of 2013.
Instead of having a broad-based focus, Juniper could narrow its investment focus to a few key categories in which the company has more scale and its core strengths lie, such as the service provider segment. The company derives almost two-thirds of its total revenues from telecom service providers, but its market share in this segment has been slumping due to growing competition from the likes of Huawei and Alcatel Lucent. Juniper’s core router market share has declined from more than 35% in 2004-05 to about 28% in 2013, by our estimates. Its market share in edge routers has also declined from about 22% to 17% in the same period. Targeting investments in these segments could help Juniper compete better and realize share gains in a market that is poised to grow strongly in the coming years as macro concerns recede further into the background.