F5 Networks (FFIV) stock is down 21% year to date after basically missing FQ2 (March) quarter largely because of the weak telecommunications vertical. The telecommunications vertical declined 35% year over year to the lowest level in recent memory. However, for the first time in four years the company has all 5 of its appliance lines refreshed and shipping this current quarter. In addition, according to CEO McAdam on the earnings conference call:
I mean, interestingly enough, we put a pretty strong start here in April, which is encouraging that we're only talking 3 weeks, remember, so -- but it's encouraging, especially in the telco vertical.
So telco is improving, they are at the onset of an unprecedented product refresh, valuation is at major support, estimates are overly conservative, and the stock just registered the penultimate Demark 13 buy. FFIV should rally to $100 into strong June and September quarters.
In FQ2 Telco was the Problem Child but has the Turn Come?
Telecommunications vertical fell from 27% to 17% of total revenue vs. a year ago. When pressed on the conference call, FFIV management stated that the issue was broad based but primarily tier 1 North American service providers. North America overall was the problem child geographically with revenue falling 4% y/y while EMEA grew 13% y/y and APAC ex Japan grew 21% y/y. The fact that service providers have resumed spending is extremely bullish when you look at guidance given. If you assume that the Telco vertical rebounds to $80 million vs. $59.5 million in the March quarter as some of the slipped deals close, then the other two verticals (i.e. Enterprise and Government) would need only to post flat y/y revenue to achieve the high end of guidance. At that revenue level, telco would still be down 13% y/y. Giving no credit for the broad product refresh, these numbers are conservative.
The enterprise vertical, representing 70% of revenue, has grown 18%, 11%, 19%, and 16% the last four quarters. Enterprise vertical showed accelerating growth to 18% y/y from 11% y/y in the prior quarter. Thus, flat y/y in the June quarter would assume things get considerably worse from here. If FFIV achieves $365 million, the high end of guidance, that will represent only 4.2% sequential growth vs. the 5 year seasonal average of 5.8% sequential growth. Clearly, after missing the quarter, management erred in being overly cautious when providing their guidance as CEO McAdam stated on the conference call when pressed:
Look, we're 3 weeks in, first of all. Secondly, we do have a good pipeline. I feel good about a lot of the drivers. But we had a big miss last quarter. And given that scenario, I think you have to be cautious. And in fact, I think cautious is being prudent. So hopefully, we're being appropriately cautious and prudent.
All Products Refreshed This Quarter
The recently refreshed BIG IP 4200 performed well following its refresh in the December quarter. The BIG IP 2000 and BIG IP 10000 should show similar traction in the coming June quarter following their releases in the March quarter. The last two appliances to be shipped are the mid range 5000 and 7000 products this coming quarter. On top of the refreshed products, the company will be shipping out their updated BIG IQ management software that allows companies to optimize and move applications around between the clouds, private and public. Software will continue to increase as a percentage of revenue from 11% in FY'12 (September) to high teens this fiscal year, led by the security modules. All five appliances will be refreshed and shipping, the first time in 4 years along with BIG IQ. Yet growth is modeled to decelerate and come in below seasonal average? Management is savvy and is setting themselves for an impressive beat.
CSCO Replacement Potential
Cisco (CSCO) announced its exit from the ADC market and a partnership with Citrix (CTXS) to resell their Netscaler product. Cisco's market share represents about a $200 million opportunity for the other ADC vendors to capture. Citrix has clearly benefited the most with it's Netscaler product growing 50% y/y in an otherwise weak March quarter. With their revamped product portfolio, FFIV should be primed to compete better versus Citrix to acquire the Cisco business. Interestingly, FFIV commented that they are winning a good deal of the business but it is showing up in their backlog, likely products that have yet to be shipped. (Quote below from the March quarter conference call when asked about the CSCO opportunity)
Regarding ACE, I think it's a really good opportunity for us. I think that opportunity is going to last a while. I mean, I wouldn't put a timescale on it, but awhile. But more importantly, and we'd said this a number of times, when we're winning, especially in the bigger accounts, that doesn't need to be Fortune 500, but Fortune 500 large organizations. The chances of us doing repeat business and the chances of us expanding our solution portfolio is really, really high. It's a big chunk of our pipeline now, the ACE opportunity. The actual close rates are pretty reasonable, and our competitive win rate has been excellent -- has been really excellent. Now having said that, we don't dismiss the Cisco-Citrix partnership. We've seen it in some areas. But more often than not, we tend to be competing head-to-head with a competitor without Cisco being too much involved.
Very Little Downside, Catalysts on the Horizon
Based on Monday's closing price, FFIV is trading at 17x '13 and 15x '14 p/e and 3.4x and 2.6x EV to 2013 and 2014 revenue, respectively. FFIV's balance sheet is pristine with $15 in cash per share and they have a buyback authorization in place that one would have to think they are actively putting to work given the stock level. On a technical basis, the stock has reached the penultimate Demark 13 buy signal and is confirmed for those Demark cognoscenti. Catalysts besides a strong June quarter include Interop later this week where they may show off their diameter routing products from the Traffix Systems acquisition along with their new products. Now is the time to own FFIV with a very conservative bar for the June quarter followed by their strong fiscal year end September quarter. My conservative upside price target is $100 representing 30% upside which would have the stock trading at high teens off of FY'14 earnings.
Additional disclosure: Consider for pro please