Juniper Networks (JNPR) is expected to announce its Q1 2013 results on April 23. The networking vendor has of late seen its new products gain healthy traction in the marketplace, helping it post year-over-year growth in revenues in the last two quarters of 2012 as opposed to the mid-single-digit decline seen at the start of last year. Last quarter, the company beat its revenue guidance at the midpoint by about 2% and gave a Q1 outlook, which suggested that it is optimistic about continuing its recent good performance in 2013 as well. What is most pleasing about the recent spate of good results is that Juniper has beat guidance despite a continuous decline (for the last several quarters) in the size of the overall service provider market -- a market segment that contributes almost two-thirds of Juniper's revenues.
Service provider spending on network infrastructure has been sluggish due to macroeconomic uncertainty surrounding the European debt crisis, which should continue to be an overhang on the industry in the near term. In the recent quarters, however, network spending in certain heavyweight regions such as the U.S. and parts of Europe have shown some signs of improvement. It will be interesting to see if the trend holds up in Q1. Concerns over the macro environment has taken a toll on rivals Alcatel-Lucent (ALU) and Cisco (CSCO) as well, with the latter doing slightly better than the rest.
However, we continue to be positive about Juniper's outlook as the long-term trends of data growth and mobility remain strong, which the company should be able to capitalize on as its new products gradually gain more momentum. We maintain our $25 price estimate for Juniper, about 45% ahead of the market price.
Data Demand Grows Despite Macro Concerns
As long as macroeconomic conditions remain uncertain, Juniper's customers are likely to remain cautious with capital spending. However, Juniper said during the January earnings call that it expects service provider spending in the U.S. to continue and that it is seeing signs of improvement in EMEA spending. While Juniper's guidance for Q1 2013 isn't very rosy, it implies year-over-year growth of about 3% at the midpoint -- much better than the decline of 6% in Q1 results last year.
It is however too early to say if business and service provider spending on network infrastructure has returned. This uncertainty is an industry-wide concern with even industry heavyweight Cisco maintaining a conservative stance while setting quarterly expectations. However, we see this as only a near-term phenomenon since despite macro concerns, data demand has continued to grow unabated, strongly driven by the key trends of mobile Internet and cloud computing. Data center traffic, which grew to approximately 1.8 zettabytes in 2011, is expected to quadruple by 2016. Mobile data traffic is also growing exponentially by almost 70% every year and is expected to grow thirteenfold in the next five years, according to a new Cisco VNI report.
The ongoing economic concerns have therefore resulted in longer project cycles and extended delivery timelines from customers. Capital spending on networks, and hence Juniper's revenues, should once again grow as economic conditions stabilize. 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, with some of the largest U.S. wireless carriers such as Verizon contributing over 10% in 2012. AT&T, also one of Juniper's bigger customers, has increased its capex guidance by $14 billion over the next four years.
Further, we see Juniper's recognition of the SDN threat and its coming up with a strategy to counter that to be a big positive as it not only mitigates the impact of hardware commoditization, but also positions it well for a new trend that has been gaining ground. Its recent launch of a programmable core switch, the EX9200, which provides compatibility with not only existing SDN protocols but also new ones as they develop over the next decade, shows that the company is finally taking the SDN threat seriously. (See also: "Juniper's Software Defined Networking Plans Come To Life With New Programmable Switch.")
R&D Spend a Good Sign of Continuing Innovation
As a consequence of the recent slump in revenue growth, Juniper has had to take a margin hit due to high fixed costs for its innovation business. Its operating expenses had increased in 2011 even as revenues dropped due to high levels of R&D investment that the company maintained throughout the year. We like the fact that in 2012 as well, despite the decline in revenues, the management never cut down on these expenses to boost margins.
This is a good sign because thanks to relentless R&D spend, the company is now seeing market share gains on its new products. The positive impact could be seen in last quarter's guidance beat, but the effect will be even greater when global economic conditions improve. The new products have also helped increase the mix of higher-margin routing products, bolstering Juniper's gross margins by more than 2% year over year last quarter. We expect the new routing products to continue to improve the firm's overall product mix and provide support to its product gross margins going forward. The impact would however be gradual since new products generally need time in the market to start having a meaningful impact.
Disclosure: No positions.