Juniper (NYSE:JNPR) recently disclosed that it is reducing its worldwide headcount by 6% and will dispose of around 300,000 square feet of leased facilities to generate cost savings and right-size the company, in accordance with its restructuring plans announced in February. The network gear maker will record cash charges of $35 million in the first quarter of 2014 to account for employee-termination expenses, and about $70 million for the rest of the year in facilities restructuring charges. It is also discontinuing the product development of its application delivery controller (ADC) technology that it licensed from Riverbed Technology (NASDAQ:RVBD) for $75 million in 2012. The move is expected to cost Juniper around $85 million in non-cash asset impairment charges in Q1.
The job and portfolio cuts come amid growing pressure from activist investors such as Elliott Management to improve the company's finances and increase shareholder value. As a result, Juniper unveiled an "Integrated Operating Plan" which promises to return $3 billion to shareholders over three years and cut $160 million in operating costs by Q1 2015. We believe that much of the attraction for long-term shareholders isn't so much the return of capital in the near term as the reorganization that Juniper is undertaking to reduce expenses and grow more focused. Repurchasing shares may allow Juniper to return excess capital to shareholders while reducing share count and increasing EPS levels. However, not much will change from a free cash flow perspective. On the other hand, a reasonable reduction in operating expenses, brought about by workforce reduction and limiting of R&D focus to a few key areas where Juniper's core competencies lie, could lead to market share gains, an increase in cash flow and create long-term shareholder value. Our $28 price estimate for Juniper is about 6% ahead of the current market price.
Restructuring To Improve Cash Flows By $100 Million
Juniper has historically been an innovation-focused company, relying heavily on an expensive R&D budget to out-innovate rivals and gain market share. Its R&D costs as a percentage of revenues have generally been among the highest in the industry. Juniper's R&D spend as a percentage of revenues of about 21-22% is about 9 percentage points higher than peers such as Cisco (NASDAQ:CSCO) and F5 networks (NASDAQ:FFIV), according to Elliott.  Reducing this to peer-average levels of 11-12% could drive cost savings of about $420 million in the longer run. Juniper's plan to cut expenses by $160 million, on the back of the ongoing restructuring initiatives, is about 40% of that and can be reasonably expected to be achieved in the near term.
If Juniper realizes the planned cost savings by 2015, we expect its OpEx as a percentage of gross profits to decrease from around 63% in 2013 to about 54% two years out. Consequently, its EBITDA margins would improve by almost 540 basis points (5.4%). Adjusted for taxes, this could lead to an improvement of more than $100 million in free cash flow, going forward. Our current estimates assume that the company will be able to implement its planned initiatives successfully and realize the aforementioned increase in cash flows as a result.
Scaling Back Product R&D
However, in order to realize these cost savings, Juniper will have to scale back efforts to develop new product lines such as QFabric and reduce R&D expenses in underperforming businesses such as security. The decision to discontinue R&D on its licensed ADC platform is in line with this strategy, given that the product line wasn't contributing to its top line at all. Cisco also exited the ADC market in 2013, after losing more than 50% of its market share to F5 and Citrix in three years (F5 Networks And Citrix Systems Benefit From Cisco's ACE Exit, September 24, 2012).
Streamlining the cost structure to decrease exposure to underperforming business lines could allow Juniper to eliminate distractions and target investments in its core carrier product portfolio and edge routers. The company derives almost two-thirds of its total revenues from telecom service providers, but its market share in this segment has been slumping due to growing competition from the likes of Huawei and Alcatel-Lucent (ALU). Juniper's core router market share has declined from more than 35% in 2004-05 to about 28.5% in 2013, by our estimates. Its market share in edge routers has also declined from about 22% to 17.6% in the same period. Focusing on these product lines could help Juniper regain its lost market share in the coming years, while allowing it to return excess capital back to shareholders.
Disclosure: No positions.