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5 Things to Know About F5 Networks

By Billy Duberstein - Apr 6, 2017 at 2:33PM

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F5 is an IT leader in transition. Here are five things investors should know about the company.

Tech investing can be intimidating. There's a large amount of jargon, and the space moves quickly. Still, the world is only becoming more technological, so the industry is hard to ignore as part of one's portfolio.

One company investors may wish to look at is F5 Networks (FFIV 0.20%). F5's products enable the efficient management and delivery of applications across large enterprises. In recent years, it has expanded its offerings with security products, as well as other advanced solutions related to data, applications, and efficient network management.

While those outside corporate IT departments are unlikely to ever use F5's products, they are mission-critical to businesses worldwide. Here are five things to know about the company.

Grayscale stock chart

Image source: Getty Images.

1. It's refreshing its product line

It's best to buy shares of hardware or software companies at the right time in their product cycles. Apple investors can relate, as the narrative around that company seems to rise and fall with each generation of iPhone every two years.

In fiscal-year 2016, F5's growth slowed. While its services segment posted strong growth for the year that ended in September, the product segment, which makes up roughly half of revenues, declined 4.7%.

This past quarter, however, the company refreshed many of its product offerings. These include its core iSeries products; its Herculon security products; its Traffic Management Operating System; its Application Connector tool, which allows applications to draw data on both public and private clouds seamlessly; and a new product called "Project Velcro" that better enables container-based application development.

The company indicated sales of the new iSeries are tracking higher than in previous product refreshes. Management also stated that product cycles typically last three years, so If the new products are a hit with customers, the next few years of product revenue could be much better.

2. Security and software products are growing fast

It is unsurprising that as revelations of high-profile cyber-attacks seem to appear in the news every few months, security products are in demand. F5 management noted on the recent first-quarter 2017 conference call that while overall company revenue grew 5.4% year over year, security products grew by double digits, and management expected this trend to continue. Moreover, the company is adapting to a world where software is challenging the primacy of hardware, and management also pointed to strong software growth, with a 2017 run rate of $400 million, or roughly 20% of total revenues.

3. Huge returns on capital

One sign of a business with a strong competitive advantage, or "moat," is a high return on capital it generates. F5 earns 30% return on equity, which is high. However, I think that number actually understates F5's true returns. The company has a huge amount of cash -- nearly $1.2 billion -- and no debt. Furthermore, F5, like tech companies in general, has very little capital spending, as most growth spending is expensed in research and development. By my calculations, if you adjust for cash, and capitalize R&D over three years, the company's true return on capital is closer to 80%.

4. It's getting a new CEO

While its return on invested capital is great, the company's leadership has been rocky the last few years. Longtime CEO John McAdam retired in 2015. Just five months later, successor Manny Rivelo abruptly resigned for "personal conduct" reasons unrelated to the company, and McAdam stepped back in on a temporary basis. It is still a mystery what Rivelo did, but it was also lucky McAdam wasn't too far removed.

On April 3, Francois Locoh-Donou will officially start as the new CEO. Locoh-Donou was previously a high-ranking executive at Ciena (CIEN -0.13%). From everything I've read, Locoh-Donou appears to be a well-rounded candidate, and Ciena has outperformed the competition recently.

F5's press release pointed to Locoh-Donou's "multi-disciplinary and multinational experience." Locoh-Donou is also on the board of an organization called Jhpiego, "a non-profit global health affiliate of Johns Hopkins University dedicated to providing high-quality healthcare for women and their families in developing countries."

5. It may be a takeover target

In a December note, Citigroup analyst Jim Suva upgraded the company as his top pick in the IT sector. The basis for the upgrade wasn't anything mentioned above, but rather the company being a takeover candidate.

This is, of course, speculation; however, in its 10-K, F5 notes it has close strategic partnerships with a number of large IT players such as Cisco Systems, Microsoft, IBM, Hewlett-Packard Enterprise, and VMware. It's possible any of those companies could be interested, though we will have to see, as the company would likely command a hefty premium to its $9.5 billion market cap.

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