F5 and the End of the "Cloud Premium"

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Momentum-chasers in F5 Networks (Nasdaq: FFIV  ) found out the hard way yesterday that a parabolic rise in stocks does not last forever. Longer-term investors in the stock also certainly felt the sting of yesterday's more-than-20% decline. Just remember that this stock's still up about 100% in the past year, and about 500% over the last two years.

There's little doubt that companies supporting cloud computing will play an important role in enterprise growth over the coming years. However, even if business trends remain strong, stock prices can't rise forever. With much of this sector inflated to sky-high valuations, I've recommended that investors look for other ways to find value in the cloud.

As Anders Bylund wrote yesterday, F5's quarter was not bad -- actually, it was quite good. F5's simply fallen victim to momentum gone bad. F5 is still taking share and growing faster than competitors Cisco Systems (Nasdaq: CSCO  ) , Brocade Communications Systems (Nasdaq: BRCD  ) , and Citrix Systems (Nasdaq: CTXS  ) . However, even after Thursday's drubbing, F5 remains valued significantly richer than its peers:


Enterprise value/EBITDA


F5 Networks 32.91 56.7
Citrix 26.55 45.9
Brocade 7.92 15.16
Cisco 7.90 22.8

Source: Yahoo! Finance.

The sell-off in shares of F5 Networks knocked down just about any stock that was even loosely attributed with cloud computing. I agree with another of my Foolish colleagues, Tim Beyers, that selling Rackspace Hosting (NYSE: RAX  ) because of disappointment with F5 Networks makes no sense. But it also doesn't make sense to ignore that general optimism for all things "cloud" lifted the entire cloud space to the lofty levels from which it's now fallen. Even companies such as Microsoft have tried to characterize their core business as cloud computing to gain some of this cloud premium.

I believe the actual tangible businesses of real cloud companies are too important to call this a bubble. However, two important factors lead me to believe that the days of the "cloud premium" are over.

Inside the machine
As investors and momentum traders bought F5 shares hand over fist during the last year, a small group of people have done just the opposite. Company insiders and large shareholders have sold more than $45 million worth of F5 stock during the last six months, or about 45% of their holdings. In addition, no insider purchases offset some of that selling.

These insider sales are still small when compared many other recent momentum stocks that enable the cloud. For example, Rackspace insiders sold more than $121 million worth of stock over the last year; Riverbed Technology (Nasdaq: RVBD  ) insiders unloaded more than $146 million; and (NYSE: CRM  ) insiders, including CEO Marc Benioff, sold a staggering $322 million in stock during its massive run-up over the last year.

These lopsided insider transactions don't necessarily mean that those inside the company believe its stock is overvalued. For example, many have insiders who have the majority of their wealth tied to the stock, and sell off a portion of their ownership at regular intervals. However, it would be nice to see maybe just a few purchases from some high-level executives. I believe this is a clear warning sign, and I'd wait for signs of insider purchases before jumping into any of these stocks myself. If the folks running the company aren't confident enough to buy or even hold shares, why should I?

Analyst uproar
You'll find another warning sign in Wall Street analysts' eagerness to defend F5 Networks late Wednesday, and throughout the day on Thursday. Many of these analysts raced to the financial media wires to reiterate their "buy" or "outperformance" calls. More troublingly, at least four analysts had just raised their price target this month, with a high of $170 and a low target of $150.

Double trouble
This troubles me, because I believe much of the momentum and the premium priced into F5 Networks and some of the other cloud companies are based on this great cloud story. It started to pick up real steam in the investing community in 2009, and by the end of 2010, even my grandfather was asking me how to invest in the cloud. The story is still good, but it's also a very well-known trend -- and a crowded trade. These companies will continue to benefit, but I believe investors looking for continued parabolic moves in these names are in for a surprise.

Forget about Wall Street analysts, institutions, retail investors, and even my grandfather. When the actual people inside these cloud-centric companies are ready to buy, I will be, too.

Microsoft is a Motley Fool Inside Value recommendation. and Rackspace Hosting are Motley Fool Rule Breakers recommendations. The Fool has created a bull call spread position on Cisco Systems. Motley Fool Options has recommended a diagonal call position on Microsoft. The Fool owns shares of Microsoft. Motley Fool Alpha owns shares of Cisco Systems. Try any of our Foolish newsletter services free for 30 days.

Fool contributor Andrew Bond owns no shares in the companies listed. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Read/Post Comments (4) | Recommend This Article (10)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On January 21, 2011, at 2:54 PM, will19699 wrote:

    Where were guys to write this article when FFIV was $140? Then you could have credibility and now be a hero. It's easy to say sell and complain when it lost 20%. They is not genius idea. Tell me something that actually has a smart forecast, instead of after the fact.

    I say do opposite of what Montley Fools says. FFIV is a buy with $30 discount. If it were not the case then you would have told us to sell at $140.

  • Report this Comment On January 21, 2011, at 2:55 PM, BradReeseCom wrote:

    Hi Andrew,

    Here's what RBC Capital Markets Managing Director - Mark Sue had to say about F5 Networks yesterday:

    "Some increased seasonality at F5 meant an in-line quarter, ending a string of six quarters of positive upside. The company is larger now and with sales accelerators winding down, F5 reported revenues of $269M (+6% QoQ) vs. the consensus of $270M. Guidance is $275M to $280M vs. the prior consensus of $281M. F5 has missed or had in-line quarters before only to come back strong and its pipeline looks healthy, the win rate is consistent and there are numerous new products in the works. We don't think there's anything systemic going on, nor are there any unusual competitive dynamics, but the multiple got out of hand at 40X.

    "Pulling in some business meant a book-to-bill less than 1.0 for the first time since March 2009. Bottom line results were strong with EPS of $0.88 vs. the consensus of $0.82. When it's all said and done our new CY11 EPS is $3.63, up from $3.60; CY12 increases to $4.30 from $4.20. Apply 25X and it's an interim target of $108 which is where we think the stock will settle. Unlever the earnings, its closer to $4.16, and apply 30X it's $125. Add cash back and it's $137."

    Sue continued, "Application delivery revenues (97%) increased +5% QoQ, which now includes FirePass. ARX (3%) continues to disappoint, making us wonder why this deal was ever done. ARX revenues were $7.2M (-1% QoQ) and F5 noted that it may be easier for customers to delay ARX orders. North America (59%) increased +4% QoQ, Europe (22%) increased +6%, Asia (13%) increased +15%, and Japan (6%) increased +6%."

    Sue added, "GMs were essentially flat at 82.6% and OMs increased from its high of 37.8% to 38.2%. F5 added 120 in headcount this quarter and plans to add 125 in 2Q11. F5 generated $103M in cash from operations and ended the quarter with $952M ($11.66/share)."

    Sue concluded, "So, it's not what investors were expecting but considering the pipeline, the conservative guidance and new products (Victoria and TMOS Version 11 in beta testing), we would stick with F5. Competitively, we're not seeing any unusual activity and it's lower but the sequential growth overall for F5 still remains healthy."


    Brad Reese

  • Report this Comment On January 21, 2011, at 3:15 PM, dirtywhiteboyiiz wrote:

    With respect

    Cloud premium is not over

    you 'll always pay a premium for whats hot, be it a concert a stock etc

    F5 got hammered

    fcx got hammered as they said prices of copper should decline but the demand is huge

    Yes I am long other cloud names

    But just like I had to laugh at the downgrade of companies by the "experts" AFTER THE CARNAGE , THIS ARTICLE FALLS INTO THAT CATEGORY

    Like I stated, I am biased because I own in the sector, but I am also objective or I wouldnt continue to own

    I cant change the facts or perceptions so its not about that

  • Report this Comment On January 26, 2011, at 9:56 PM, Blueman1000 wrote:

    I've said it before and now I'll say it again, I've read all the articles, all the definitions, you name it and I've looked into it. "There is no such thing as Cloud Computing". It's networking by another name, it's file sharing by another name, will someone post their definition to Cloud Computing and then sit back and watch the other 10,000 definitions pop up.

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