Infoblox Could Become Essential To Its Customers

Mar.19.14 | About: Infoblox Inc. (BLOX)


Infoblox's network management and automation products will help improve quality of enterprise networks while keeping support staff costs down.

DNS is becoming a high value target for hackers with potentially devastating consequences while being poorly protected, and Infoblox has released products to fix this security hole.

Lack of substantial debt gives Infoblox some cushion for the timing of contracts, while most of its potential customers do not have any kind of network management solution.

One bad quarter brought the share price down substantially, taking some padding out of the valuation and making it a strong potential investment based on fundamentals.

Infoblox (NYSE:BLOX) is a company that relies on growth to drive its stock price, and without active news generation the earnings reports are going to be the prime movers of the share price. A growth driven stock requires an understanding of its product offerings. There is not much information out there about what Infoblox does, so I decided to look at white papers and datasheets. I am not an engineer, but as an investor you only need a basic understanding of the technology and products. A poorly managed company with a great product is at least a buyout target, while a company with a pointless product will disappear eventually.

I will start by looking at the products and services that make up Infoblox's primary business of network management and automation. Then I will consider the new security product line that the company hopes will become a major revenue driver in the future. This is followed by analysis of the most recent earnings call and the company's finances. Finally, I will discuss some ideas for managing an Infoblox investment.

Network Complexity Requires New Tools

Infoblox offers products that can help network engineers see the entirety of the network, and automate the most basic tasks. Visibility is important for troubleshooting problems. Automation helps keep staff numbers lower and provides consistency.

Infoblox allows an engineer to see all the devices on the network as a basic feature. The same appliance also allows the engineer to manage the network as a whole, or some assigned part thereof, from the terminal. The three basic functions that Infoblox helps manage is referred to as DDI, which is DNS, DHCP, and IP.

For those of you unfamiliar with networking terminology, DNS is the system that turns a web address into its underlying IP address. DNS is a foundational aspect of the Internet that needs to be configured and working properly, and it is a potential security weak point. Infoblox offers security solutions now, which I will discuss below. DHCP stands for Dynamic Host Configuration Protocol, and is the system responsible for automatically assigning IP addresses. The last part of the acronym stands for internet protocol, and encompasses other basic aspects of the network. Infoblox can help cut down on IT staff by simplifying configuring and maintaining networks.

Nowadays networks cut across geographic locations, and the Infoblox appliances incorporate this reality. It also allows a network engineer at one location to see the configuration of the whole network, while only being able to make changes to the network under his control. This is a great feature that uses a big picture approach in line with the existing reality and trend of business networks.

Prior to Infoblox, and still in many places, engineers would create their own fixes and tools for problems specific to their networks and skill set. I have seen this firsthand. The problem is when that person takes a vacation, retires, or quits. Infoblox provides a solution to all this and fits on top of the existing network architecture. Since Infoblox is not a vendor of general network hardware, it strives for compatibility across the spectrum, instead of specializing on one brand or line of products.

Providing Security

Network security is a crucial but oft neglected, component of any network infrastructure. Emphasis is usually put on service, expansion, and controlling costs. Security is the kind of thing you hope you can cheap out on and get away with it.

One of the most common type of security breach is actually the denial-of-service attack, which aims to crash a server and disrupt services. It prevents users from accessing the site and in the case of service providers can hurt consumer confidence. Imagine if you could not access your brokerage on a critical day. The attack itself is a simple concept. The target server is flooded with so many requests that it is overwhelmed, and slows to a crawl or stops completely.

Security has two goals when to comes to these types of attacks. The first is to protect the network itself, which is the universal aspect of security. The second reason to have security in the case of denial-of-service attacks is to prevent your network and networked machines from being hijacked to attack another network.

From the white papers on Infoblox's website it seems that they are focused on one type of denial-of-service attack in particular. I am sure that their security products can handle the basic attacks as outlined above, but their focus (pdf) is on DNS-based denial-of-service attacks. I think the reason is that DNS servers are relatively unprotected, or at least that is their claim, but being a foundational part of the Internet makes it a target.

DNS servers can be used to amplify denial-of-service attacks by many orders of magnitude. One compromised server can compromise other perfectly secure servers. There are ways to prevent an attack like this, but not all DNS servers are configured in the best possible way. This article explains these attacks in far more detail.

In the digital world we live in a little downtime is not acceptable. That offers the simplistic explanation of why the solution to a denial-of-service attack is not just to turn the server off and then turn it on later, or just wait till it stops. There are other reasons as well. The attacks can have unintended consequences and can even knock out Internet access in a whole region. It is called the Internet, because everything is connected. Attacking one part can have consequences for other parts. Security measures protect all networks not just the one it is installed on.

This being the newest of Infoblox's initiatives, I thought it was important to explain it a bit more to judge its potential. Automation is not a legacy product with dwindling revenue. Both product lines are expected to grow and drive revenue. I think security has the potential for more specialized services that will keep Infoblox with contracts. Automation and management tools are more general and could be offered by networking hardware and software vendors. Security can be incorporated, but having a dedicated solution is usually seen as being more effective. It is the same reason almost everyone uses additional software to protect their machines, whether they are firewalls or antivirus software.

Customers Will Become Dependent on Products

Looking into and writing about Infoblox's products got me thinking about the role that the company will play into the future. The future is a long ways away and there are plenty of things that can change in the mean time, but Infoblox is well positioned.

During times of poor growth, companies might not expand their networks, but they will have to continue their contract with Infoblox for management and security. Recurring contracts for service, support, and updates are the norm. Once your network and your staff are using this system, it is not easy to just quit. At the most you could shift laterally to another company, but shifting to another solution provider is not easy. All the hardware needs to be replaced, and staff trained in the software.

I found it difficult to find a good list of actual competition. All the standard sites had big companies like Hewlett-Packard listed. Competitors to Infoblox include SolarWinds (NYSE:SWI) and private company Bluecat Networks. Some might say that Riverbed Technology (NASDAQ:RVBD) is a competitor, but they are also a technology partner with Infoblox. The companies might be slightly in competition, but probably not direct head-to-head competition. This is an emerging technology and there is room for all the competition to grow side-by-side. Grabbing market share will be more important once the technology penetrates deeper into the industry.

Once a company goes with Infoblox to manage the network, it has to continue to expand those products along with its own networks. It would be inefficient and problematic to manage a part of a network with Infoblox products and a part of it manually. As machines and devices get added to the network, the scale of the management solution will have to increase as well. This creates growth from an existing customer base.

Infoblox offers a cost-cutting solution. That means that its sales could improve, or at least be maintained, during tight times when companies are focused on profit as revenue growth stagnates. Infoblox helps keep staff numbers lower by allowing one person to accomplish more.

In my eyes, all of the things mentioned above point to Infoblox being fairly resilient once it gets going. New customers, installation costs, and initial hardware outlays will drive earnings and send the share price higher. The recurring contracts will help protect the company from macroeconomic weakness, and will eventually become the bulk of revenue.

Bad Piled on Bad

"Three factors, all of which would not typically happen in a single quarter," was the opening to the explanation of why the last quarter saw lower revenues during the conference call. The CEO assured that the company will take efforts to prevent all three factors from hitting in the same quarter. It does signal that the problems faced this quarter might not go away, so do not expect an earnings blowout next quarter. One data point is not a trend, but investors need to be watching like hawks. Revenue was up year-over-year, but down sequentially. With a company like Infoblox you want to see a consistent increase in revenue quarterly. Growing companies need to grow to justify their valuations.

The best part is that investors who have waited on the sidelines have a chance now if the underlying business is healthy. You can take a chance now, or you can wait till at least one more quarter. Another quarter of soft sales would be a red flag. Regional weakness is a roll of the dice. It might get better or it might get worse. It really depends on the outlook of business and whether they want to start spending money, or if they plan to hunker down through a rough patch.

Ukraine and Crimea are in the news now, and it could be some other crisis later. It does not take much to light the fuse of fear, but building confidence takes time. That is the same reason that it will probably take more time to bring Infoblox's share price back up than it did to take it down.

Federal contracts came in lower as well, which is not too surprising considering federal budgetary issues. That is not to say that the federal contracts won't come through eventually, but it is also a roll of dice. I am not using roll of the dice to signify randomness, but only unpredictability. Acknowledging uncertainty, it allows you to make your investment decisions properly. I will go over potential entry strategies below.

Overall, I agree that the market trend favors products that Infoblox makes as stated in the conference call. There is no need to go over the specific customer wins, but if you get the chance to read them, do so to understand how the company operates. For something like this, the hardest part is convincing companies that they need the product. It will take some time, but companies do need the product.

A Look at the Fundamentals

I specifically wanted to write about Infoblox to discuss what the company did. The fundamental picture is something that most investors can understand on their own. The second half of the conference call talks all about it.

I just checked for a few of my normal numbers. Cash looks good and on an uptrend, and there is some free cash flow. Cash and cash flow are some of my favorite fundamental measures for health. For all the trouble a bad quarter caused for the share price, the company is not on life support. Nothing is listed under long-term debt, and checking the financial tables on the Infoblox website shows no long-term debt. All the numbers are there for review. There is nothing that screams about Infoblox being worth some exorbitant number and sooner or later the market will notice, but nothing worries me excessively about it.

Invest With a Plan

I do think Infoblox has a great product, and the one quarter miss is not something to freak out about. Like most stocks I end up liking, this one has a fair amount of risk. I would consider two strategies, both with risks. The first takes a smaller initial position and seeks to lower risk by returning cash through writing covered calls and secured puts. The second position involves taking a full initial position and potentially writing covered calls at higher strikes. I do not buy puts as insurance against a decline.

The more conservative strategy involves taking 50% the size I want, and then write some secured puts in case of further downside. I would also try and write some covered calls a fair bit out of the money and into the future. This would help to mitigate any potential decline by collecting premium in the meantime, while ensuring you can expand your position at a lower level. Just remember that you have to pay the strike price on the put you write and its 100 shares per contract. This is a good plan for those familiar with writing options and want income, or just want to be conservative with an Infoblox position.

I would go with puts around $15 with at least a month of time. As of March 18, 2014, I would wait till the May options show up, but you could go with the July ones if you do not mind carrying the position. For calls, I would go with $35-$40 and choose at least 3 months of time with no more than 6 months. Lower strikes can be considered if you do not mind giving up the profits from large swings. You can write more options as they expire. After the next earnings, you might consider dropping puts if the company is doing better.

My strategy of choice involves taking a full position I could live with and do only covered calls. It would be slower for pulling in hard cash than writing calls and puts, but you'd have more shares to write calls against. However, my strike of $35 or even $40 for calls would bring in less premium than the same expiry for $15 puts. I would take on that additional risk based on the fundamentals.

I also trade options in lieu of owning the stocks themselves. Nearer to the next earnings report, I might consider picking up some calls at $30 if the share price is still in the low $20s and after reading any analyst coverage and expectations. Good news would bring the stock back to where it dropped off. Options trading is far riskier than writing, and should only be undertaken if you understand the risk and know how to trade options.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Disclaimer: Always do your own due diligence to confirm information.