"You won't kill me out of some misplaced sense of self-righteousness. And I won't kill you because you're just too much fun. I think you and I are destined to do this forever." Joker, Dark Knight
This is not an article about a great investment idea, but it is just one I had to write.
Earlier today, I contacted a couple different people I know regarding F5 Networks (FFIV) to toss around the idea of buying puts ahead of the upcoming quarterly earnings release. I had no intention of doing anything today as I am on a bit of a market break, but I had just come across a flurry of upgrades the day before that I just couldn't ignore. I had a small put position into F5's last earnings report under the assumption that it was getting close to a rerating and was worth the exposure. The position was small because the networking group has been on a roll, I wasn't super confident of the timing, and because at the time I had a grab the bull by the horns risk/reward position in Deckers (DECK). However, I had been on F5 as a bear for a while and made some good money shorting at slightly lower levels, so passing on it one quarter deeper into a slowdown thesis after a 20% rally was not something I was willing to do. This was despite the fact that I knew networking stocks were in the midst of a strong rally. See, I don't mind fighting the tape when I have some conviction, and having been on and off long Cisco (CSCO) and Juniper (JNPR) for the previous few months, I felt I had a pretty good idea of how the sector was trading. Basically, F5 was coming to the end of a milking the ADC sweet spot cycle, while the rest of the big players were turning the corner on a miserable stretch of margin erosion in the broader networking space. If the networking momos were going to walk into a trap, F5 was going to be it, and I was not going to miss it.
As I recall, the stock went into earnings around $97-$98, and when results came out, it didn't do much. Hardware sales continued to slow, and the evidence of growth being carried by the services division continued to mount. Yet, guidance was surprisingly strong, and when the conference call started, the uber-bullish tone out of management pretty much guaranteed that my puts would soon be worthless. Not exactly a shocker, and if that was then I wouldn't be writing this article. See, despite the great outlook and very positive tone, F5 didn't hold its slight gains for more than a couple of weeks. And then it did something that really caught my attention; it started to drastically underperform a very strong tape. By March the shares were trading 13% below where they had been going into earnings despite no material news.
Something was up right?
Anyone familiar with the name that had listened to that conference call would have to had been out to lunch not to notice what the price action was saying. Word was clearly out that its quarter was not going to plan, and with such an uber-bullish conference call behind it, a miss would spell disaster. But when you have a short bias on a stock that is trading at a $100, it's tough to come back and buy puts at $87 in the midst of a bullish tape.
I had effectively been frozen out of the trade. What I needed now was a rally into earnings. Enter the sell side...
Over the past week and a half, F5 received three different uber-bullish sell-side upgrades. And with each upgrade, all I could think was this is setting up to be a major sell-side embarrassment, and there is nothing better than a good sell-side debacle if you are shorting a stock. Break be damned, if F5 was going to miss/warn I needed to be on it! So I got up today shot out some emails and made some calls. The light bulb was on. I was already figuring out what options I needed to buy, and how to size the trade.
Then disaster struck......
F5 pre-announced a huge miss after hours. Yes folks, the market can be a cruel beast sometimes.
But there is a lesson here and it is one that I suggest any investor pay close attention to, and that lesson is to not ignore major divergences because they rarely end up being proven wrong. If I was covering this stock, the LAST thing I would have done after that last conference call was upgrade it here after it was down 13% in a strong tape. F5's product sales have been markedly slowing, service revenue growth deserves a lower comp, SDN is shaking up networking, and management has a history of being a little bit too bullish. Put that altogether and an underperforming share price should scare the hell out of you. Yet all three upgrades did nothing more than regurgitate the standard F5 bull thesis of the last two years. Yes, some things will never change.