F5 Networks Not Out Of The Woods Yet, Wait For $100

| About: F5 Networks, (FFIV)

Summary

The stock doesn't deserve a passing grade until F5 demonstrates it can deliver the goods on a more consistent basis.

Investor have to reconcile the direction of the company. Management still has not sufficiently outlined who and what F5 is.

Weak profits suggest that Cisco and Juniper are eating into F5's margins. F5 is being forced to drop prices to win business. But this can't help investors long term.

There is no market considered "worthwhile" that doesn't attract plenty of competition. This much is learned early in every business school. So it continues to surprise me how much F5 Networks' (NASDAQ:FFIV) management has underestimated rivals like Cisco (NASDAQ:CSCO) and Juniper (NYSE:JNPR).

While F5 has executed much better, helped by improved business conditions in the U.S. and Europe, the company hasn't been able to exploit its market advantage in areas like application delivery control (ADC). This is even though Cisco exited that market and handed it to F5 on a platter. Instead, F5′s management failed to produce the sort of leverage the company needed to grow margins and seize market share. And following the company's fiscal second-quarter report, these questions still remain.

First, the good news; on Wednesday, the company posted a higher-than-expected quarterly revenue and forecast third-quarter results that beat analysts' estimates. F5 benefited greatly from increased demand from its telecom customers. Note that F5 generates a considerable amount of business from AT&T (NYSE:T) and Verizon (NYSE:VZ), which helped F5 post 20% year-over-year jump in quarterly revenue, which arrived at $420 million -- topping last year's mark of $350 million.

In terms of profitability, the company delivered net income of $69.6 million, or 91 cents per share. This represents a 10% jump year over year. Last year, F5 delivered a profit of $63.4 million, or 80 cents per share. Unfortunately, while these results suggest that management is moving the company in the right direction, they were not enough to please the Street. The company missed on both the top and bottom lines.

Analysts on average were expecting a profit of $1.33 per share on revenue of $428.7 million. Excluding items, F5 earned $1.27 per share. Analysts on average had expected a profit of $1.25 per share on revenue of $414.4 million. By contrast, on Tuesday, Juniper reported a higher-than-expected 10% increase in quarterly revenue, helped by its telecom clients.

Recall, weak carrier spending has presented headwinds for the entire sector. So it's encouraging that AT&T and Verizon appears to no longer want to starve themselves. This was one of the reason F5 has struggled with growth, even amid one of the biggest appliance refreshes the industry has seen in the past four years.

It's also an encouraging sign that IT managers have stopped delaying purchases. The question is, how much market share can F5 management steal from the likes Citrix (NASDAQ:CTXS) or Riverbed (NASDAQ:RVBD). While management deserves some applause for the jump in revenue, particularly on the product side, the profits were weak. As noted, the company's refresh cycle in the past four years, including hardware that help manage network traffic, appear to now paying dividends. These products have found favor with customers.

Even so, the weak profits suggest that Cisco and Juniper are eating into F5's margins. F5 is being forced to drop prices to win business. But this can't help investors in the long term. As it stands, the company still has plenty of work to do. And I believe management should begin by better diversifying the business to exploit the growth potential in both ADC and SDN markets mentioned above.

Accordingly, the stock doesn't deserve a passing grade until F5 demonstrates it can deliver the goods on a more consistent basis. Investor have to reconcile the direction of the company. Management still has not sufficiently outlined who and what F5 is. Sacrificing profits for sales doesn't look like a good strategy. With the stock trading at $106 and a P/E of 30, these shares don't make sense on the basis of weak margins. I would wait for any price under $100, while looking for better value in Cisco.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Business relationship disclosure: The article has been written by Wall Street Playbook's tech sector analyst. Wall Street Playbook is not receiving compensation for it (other than from Seeking Alpha). Wall Street Playbook has no business relationship with any company whose stock is mentioned in this article.