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Summary

  • Application network technology provider went public last month.
  • Growth goes hand in hand with increased losses.
  • Litigation and competitive pressures are causing an overhang.

A10 Networks (ATEN) is a provider of advanced application networking technologies which has seen its public offering about a month ago. The offering went reasonably well after which shares have consolidated in recent weeks.

While relative valuation metrics in terms of revenue multiples are in line with competition, I am not impressed by the increased losses in recent times. Combined with litigation risks and fierce competitive pressures, I have plenty of reasons to pass on this offering.

The Public Offering

A10's application networking technologies allow companies, service providers, internet companies and governmental agencies to secure, manage and optimize data center applications as well as networks.

The company's solutions are built on the so-called Advanced Core Operating System (ACOS) which enables superior performance and security compared to legacy solutions while being flexible enough to deal with cloud as well as mobile computing.

A10 sold 12.5 million shares for $15 apiece, raising nearly $188 million in gross proceeds. The company itself offered 9 million shares and thereby raised $135 million in proceeds while the remainder of the shares were being offered by selling shareholders. In total some 21% of the outstanding shares were offered in the initial public offering.

Demand for the offering was solid with bankers and underwriters initially aiming to sell shares in a $13-$15 price range. At current levels around $14.25 the market values the equity in the business at $840 million.

The major banks that brought the company public were Morgan Stanley, Bank of America/Merrill Lynch, J.P. Morgan, RBC Capital Markets, Pacific Crest Securities and Oppenheimer & Co.

Valuation

A10 essentially offers three software application networking solutions at the moment based on its ACOS architecture platform. The three solutions target performance optimization, protocol translation services for network providers and network-wide security.

The company has sold its solutions to nearly 3,000 customers which are located across the globe. Roughly half of the revenues are generated in the US, a quarter in Japan and the remainder in the rest of the world.

Revenues for 2013 came in at $141.7 million, up by 18.1% on the year before. Net losses narrowed significantly from $90.2 million in 2012 to $29.1 million over the past year. Excluding litigation charges of $95.5 million in 2012, losses were on the increase. What is interesting to note; in 2011 A10 was profitable as it posted $7.3 million in earnings on little over $91 million in revenues.

It is reassuring to see that growth picked up in the final quarter of the year as fourth quarter revenues rose by 22.9% to $42.2 million. Losses for the seasonally strong quarter came in at $5.6 million.

Before the offering took place A10 operated with nearly $21 million in cash and equivalents while having a similar amount in debt outstanding. As preferred and convertible equity investments will be converted in normal shares following the offering, A10 operates with a net cash position of roughly $125 million. Some $20-$30 million of these proceeds will initially be used to finance the company's growth ambitions.

With a current market capitalization of $840 million, the strong cash position implies a valuation of roughly $715 million for the operating assets of the business. This values operating assets at 5 times annual revenues.

Investment Thesis

As noted above, A10 has seen a relatively non-eventful offering despite the fact that shares were offered at the high end of the preliminary offering range. Following the offering shares have traded in a relatively tight $13-$16 price range, currently trading in the middle of that range.

It is comforting to see a greater shift towards service revenues which tend to be more recurring while carrying high margins. At the same time, service revenues still only make up a fifth of total revenues as product sales continue to dominate.

While growth is accelerating a little bit in the final quarter I have serious worries. This includes the fact that between 2011 and 2013 A10 managed to grow revenues by $50 million at a high cost. Earnings fell by $36 million in actual dollar terms over this period. As such growth came at a very high price.

Other risks include competition and notably significant litigation risks. In the past the company has settled litigation matters with F5 Networks (FFIV) and Brocade Communications (BRCD) for significant amounts. Currently A10 is still in pending litigation with Radware (RDWR) and Parallel Networks. Besides battling legal issues, competition is fierce as well from Juniper Networks (JNPR) as well as Cisco Systems (CSCO).

As such I have outlined enough reasons for myself to avoid this company. I remain on the sidelines.

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.

Source: A10 Networks - Too Much Risk In Shares Of This Application Network Provider