Can F5 Deliver on High Expectations?

Growth investing can sometimes be a pain in the butt. This is especially true when you find a company that seems expensive, yet the stock will continue to climb as long as that company is posting growth numbers that the Street craves. For quite some time, F5 Networks (NASDAQ: FFIV  ) has fit this description pretty well. But the bar just might have been raised a little too high this time.

While F5 remains a strong play in network traffic management products and services, the company's no longer on the torrid growth path it once enjoyed. Nevertheless, the stock is holding up pretty well despite the fact that the company is coming off two sub-par earnings reports, including the most recent first quarter when F5 missed on both revenue and earnings-per-share estimates.

Yeah, but so what...
As have been the case for quite some time, there are still plenty of F5 bulls that want to dismiss the company's recent struggles. On Monday, Deutsche Bank's Brian Modoff reiterated his buy rating on the stock, while also assigning a price target of $116. Basically, Modoff believes there is 33% upside in these shares. I just don't see it.

Besides, given that the price-to-earnings ratio is currently trading at more than twice that of Cisco  (NASDAQ: CSCO  ) , the share price is already too high. What can F5 do, beyond doubling revenue growth to justify a premium of 33%? For that matter, revenue growth has to return to (at least) 20%. And with increased competition from rivals like Cisco and Fortinet (NASDAQ: FTNT  ) , this is no small task, especially since F5 only managed 13% growth in its recent quarter, which was only a 1% sequential improvement.

By contrast, not only did Fortinet beat on both top and bottom line estimates, but Fortinet grew revenue and net income at a rate of 25% and 26%, respectively. Bulls will argue that F5 grew service revenue 28%. But F5 managed to offset the strong service performance with a dismal 4% growth in product revenue, which also arrived down 2% sequentially.

So, absent some significant fundamental improvement, it's tough to see how F5 is going to grow in a manner that supports 33% premium in share price. In his research note, Modoff suggested that some "big banks" had shown "meaningful interest" in F5's Web application security and DDoS mitigation solutions."

DDoS, which stands for distributed denial of service, is a form of coordinated computer attack. While F5 is certainly strong in this sort of threat prevention, it is no monopoly. Aside from battling Cisco and Fortinet, there are also new entrants like Palo Alto Networks and Sourcefire that are generating plenty of excitement. In other words, not only does F5 have growth to worry about, there is now the threat of margin compression.

Can new acquisitions and products ignite growth?
While F5's growth has indeed slowed, management has not given up. Over the past couple of weeks, the company has made several new announcements, including a key acquisition in LineRate Systems, a company that develops software-defined networking, or SDN, services.

This is a deal that I felt F5 had to make, which should help strengthen the company's current lead in the application deliver control, or ADC, market. And the fact Cisco has recently exited the ADC market leaves the door open for F5, which already enjoys a 50% share, to dominate the likes of Juniper Networks, which has shown its own signs of struggling.

What's more, F5 recently announced the F5 Mobile App Manager, a new hybrid cloud solution for mobile application management, which now puts the company in a position to steal market share from Citrix and Aruba Networks. In other words, despite my bearish views, it seems the company is finally getting back to what it does best.

That said, it remains to be seen as to what extent these recent moves can ignite growth. Product revenue can't stay in the single digits, not to the extent that it justifies Modoff's optimism. As noted, these shares are already trading at five times trailing sales. Plus, with Cisco and Fortinet performing so well, F5's performance has to really stand out. Unfortunately, this is a situation where Modoff just might have set the bar too high.

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  • Report this Comment On April 04, 2013, at 11:25 PM, oolankaloophid wrote:

    maybe there is a little lack of understanding in this market.

    1. Cisco did leave but named a successor (not F5)

    2. F5 trying to build partnership with VMWare but buys a competing SDN (linerate vs nicira)

    3. They are even in the ADC space in Gartners eyes with Citrix NetScaler.

    4. They are not innovating any more, just following.

    5. Launched a new product line that offers limitations not solutions.

    6. Fails to deliver on promises (vaporware)

    Thoughts from anyone else?

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