F5 Networks, Inc. (FFIV) develops, markets, and sells application delivery networking products that optimize the security, performance, and availability of network applications, servers, and storage systems. The company offers Local Traffic Manager, which provides intelligent load-balancing and traffic management; Global Traffic Manager that automatically directs users to the closest or best-performing data center; Access Policy Manager, which provides secure, granular, and context-aware access to networks and applications; and Application Security Manager, an application firewall.
For the fiscal first quarter, management is guiding to revenues of $390M to $400M with GAAP diluted EPS of $0.81 to $0.84. Management is guiding towards high single-digit growth. I would have expected double-digit growth emanating from the BIG-IP 5000 and 7000 series refresh.
I'm bullish on F5's product refresh cycle, and valuation.
- William Blair upgraded the company to "outperform" from "market perform." The company expects performance to improve following a rough patch in mid-2013.
- The company is scheduled to release earnings after the market close on Wednesday, Jan. 22. Analysts are expecting EPS to increase 4.4% relative to the year-ago quarter.
- F5 Networks is providing network traffic and security management services for the new Verizon (VZ) Cloud.
- F5 Networks announced the launch of the LineRate product line and the availability of its first software offering. The LineRate application proxy software, running on commodity hardware or virtual machines, eliminates the need for DevOps to manually set up complex proxies or incorporate networking logic into applications, freeing their time to focus on core business logic and develop new value-added product capabilities. This will save companies significant time and effort when developing and deploying new or updated applications.
- F5 Networks announced an hourly billing model for its BIG-IP Virtual Editions, and availability of its BIG-IQ Cloud orchestration product in the Amazon Web Services Marketplace. I give this "two thumbs up."
- The organization announced the industry's most comprehensive on-premises DDoS solution available in a single product. The new solution delivers the widest ranging suite of protections against DDoS attacks that target business applications, the network, SSL, and DNS infrastructures.
F5 Networks, Inc. develops, markets, and sells application delivery networking products that optimize the security, performance, and availability of network applications, servers, and storage systems.
The recent performance has been less than stellar. F5 Networks' revenues growth trailed the industry average of 22.2%. Also, the net income growth has trailed the S&P 500. Both of these indicators suggest F5 Networks will underperform.
With that said, the 10-year growth rates are phenomenal. But growth has slowed recently. For now, I attribute the slowing growth rate to the increase of scale. Generating $1.5B in annual revenues is "big boy" status. The profitability profile is excellent, and it could be better if management decides to decrease SG&A expenditure. So, this is definitely is a solid company from a GAAP financial performance perspective.
My hurdle rate for net income is higher than it would normally be if the company's growth rate didn't slow during the past year. I need to see GAAP basic EPS above $1.75 over the next twelve months, which in this case shouldn't be a problem. It appears as though an investment in F5 Networks will not destroy my extraordinarily beautiful wealth.
The solvency and liquidity position seems to be rock solid, as is usually the case with tech firms. The cash ratio was 0.98 at the end of fiscal 2013. The current ratio was 1.48. Net cash was $542 million. The financial leverage ratio was 1.45. A dividend is probably out of the question. Additionally, the liquidity is lower than I expected because management is returning excess cash to shareholders.
That brings me to my next point. Cash flow from operations was $500M at the end of fiscal 2013 and the company doesn't invest much in capital expenditure. So, I think we could be looking at over $500M of free cash flow during fiscal 2014. FCF increased 1.7% during fiscal 2013, which followed a 22% increase during fiscal 2012.
The fundamentals of the business are solid, and 2014 could prove to be strong on the product refresh cycle, which could mean a return to double-digit growth.
- The share price is likely to remain volatile and investors could lose a portion or all of their investment.
- Investors should judge the suitability of an investment in F5 Networks in light of their own unique circumstances.
- This section does not contain all risks related to an investment in F5 Networks.
- A decline the global economic growth rate and/or a decline in the pace of economic growth in the United States could adversely impact the results of operations and the share price.
- Cyclicality in IT expenditure may affect the performance.
- The technology industry is characterized by rapid technological change, which could materially adversely impact the results of operations.
- Competition in product development and pricing could adversely impact performance.
- Incorrect forecasts of customer demand could adversely impact the results of operations.
- Higher interest rates may reduce demand for F5 Networks' offerings and negatively impact the results of operations and the share price.
Valuation & Portfolio Management
Big picture, we are seeing the share price of F5 Networks bounce off of the roughly $70 per share support level. This should setup a re-test of the $140 per share level. Agile investors would get long at this level with a trailing stop loss level starting at $80 per share. It would be about $12 of initial risk for about $47 of initial reward. (That's a trade!)
Next, investing in F5 Networks provides diversification benefits. Since 2009, F5 Networks has a correlation with the broader market of 0.53, which is statistically significant at the 95% confidence level. That drops to -0.45 since 2011, which is statistically significant. Since 2013, the correlation is -0.20, which is statistically insignificant. More recently, F5 Networks and the market have moved in opposite directions.
Movements in the market explain some of the variation of the share price of F5 Networks. Since 2009, movements of the S&P 500 explained 28.3% of the movements of F5 Networks. That drops to 22.7% since 2011. Since 2013, the number drops to 11%. So, the market explains roughly 20% of the variation of the share price of F5 Networks.
Is the Nasdaq better at explaining the variation of F5 Networks? Since 2009, the movements of the Nasdaq explain 34% of the variation. But since 2011, the percentage drops to 18%. From 2013, movements of the Nasdaq explain 6.4% of the movements of F5 Networks. The Nasdaq is no better at explaining the movements of F5 Networks.
Movements of the share price of F5 Networks may be better explained by industry or company specific variables, but the general trend of the market seems to be of little help to investors.
I use 3-month, 6-month, and 12-month price targets. The 3-month price target is $115.72. The 6-month price target is $118.68. And the 12-month price target is $124.60. These represent 30.7%, 34.1%, and 40.8%, respectively, premiums to the current share price.
In terms of outperforming the S&P 500, when I utilize my proprietary indicators to analyze the likelihood of F5 Networks outperforming the market, I don't see signs of that happening. The truth is that the evidence suggests F5 Networks will underperform the market. When the facts change, I will change my mind.
Given the size and the growth rate, F5 Networks should trade at a premium to the market. I view the current premium as too small; there is room for multiple expansion. But the PE and PB ratios are skewed by the share repurchases. Nonetheless, F5 Networks is cheap, for a growth stock, at 25.3 times earnings and 4.5 times book.