After investigating the networking sector a couple weeks ago, I was intrigued by Citrix (NASDAQ:CTXS). Let me start off by saying that Citrix Systems Inc. is a great company. They have been a leader in their sphere for years, and their growth has been phenomenal. Couple that with the fact that they just had a great Q4, and one might call me crazy for issuing a sell recommendation on this company.
However, I am firm in my beliefs that no matter the story behind a company, you have to combine that with the right price to call it a good investment. Some highly priced companies do this with explosive growth, competitive edge and proprietary technologies. Some companies individually break this rule and sometimes the market disproves this rule over the short to medium term, but I think it in the long run value prevails.
Citrix Systems has had a competitive advantage in terms of application virtualization for some time now. They have been the best option for companies hoping to run an application from a central server with XenApp, and also from remote locations using Access Essentials. Their technologies are applicable across a wide variety of operating systems, including Windows, which made them unique in this sphere; many competitors bundle desktop and application virtualization into one package.
Because of this flexibility, CTXS has a strong relationship with Microsoft (NASDAQ:MSFT), which it relies upon to avoid direct competition with companies like VMware (NYSE:VMW), who focus on more complicated holistic server infrastructures. Recently, VMW released their earnings, which beat but were tempered by soft guidance on margin outlook. Their CFO, Mark Peek said (see conference call transcript here):
The IT spending environment improved dramatically compared to 2009, and we were able to capitalize.
However, the caveat with their earnings call was a flat margin for 2011. Could CTXS be caught in the same boat? Let’s take a look at their earnings and see.
See the earnings press release here.
Q4 Financial Summary: In reviewing the fourth quarter results of 2010, compared to the fourth quarter of 2009:
- Product license revenue increased 17 percent;
- Revenue from license updates grew 13 percent;
- Online services revenue grew 16 percent;
- Technical services revenue, which is comprised of consulting, education and technical support, grew 40 percent;
- Revenue increased in the Americas region by 27 percent, the EMEA region by 7 percent and the Pacific region by 15 percent;
- Deferred revenue totaled $779 million, compared to $619 million on December 31, 2009;
- GAAP operating margin was 21 percent for the quarter, and non-GAAP operating margin was 28 percent for the quarter, excluding the effects of amortization of intangible assets primarily related to business combinations, stock-based compensation expense and costs associated with the 2009 restructuring program;
- Cash flow from operations was $179 million, compared with $178 million in the fourth quarter of 2009; and
- The company repurchased 1.9 million shares at an average price of $65.90.
Annual Financial Summary: In reviewing 2010 results compared to 2009 results:
- Product license revenue grew 15 percent;
- License updates revenue grew 13 percent;
- Online services revenue grew 17 percent;
- Technical services revenue, which is comprised of consulting, education and technical support, grew 31 percent;
- Revenue increased in the Americas region by 20 percent, the EMEA region by 8 percent, and the Pacific region by 21 percent;
- GAAP operating margin was 17 percent for fiscal 2010, and non-GAAP operating margin was 26 percent, excluding the effects of amortization of intangible assets primarily related to business combinations, stock-based compensation expense and costs associated with the 2009 restructuring program.
- Cash flow from operations was $616 million for fiscal 2010 compared with $484 million last year; and
- During fiscal 2010, the company repurchased 8.3 million shares at an average price of $53.14.
Financial Outlook for Fiscal Year 2011: Citrix management expects to achieve the following results during its fiscal year 2011 ending December 31, 2011:
- Net revenue is expected to be in the range of $2.10 billion to $2.14 billion;
- GAAP diluted earnings per share is expected to be in the range of $1.78 to $1.84. Non-GAAP diluted earnings per share is expected to be in the range of $2.29 to $2.33, excluding $0.34 related to the effects of amortization of intangible assets primarily related to business combinations, $0.45 related to the effects of stock-based compensation expenses, charges recorded in conjunction with the company’s 2009 restructuring program, if any, and $(0.24) to $(0.34) for the effect of the differential between the GAAP and non-GAAP tax rates and tax effects related to these items.
By all estimates, a solid quarter. Revenue growth was solid all across the board, and their per share earnings guidance of $2.29-2.33 beat the street's estimate of $2.28. The other strategic issues surrounding Citrix are what I feel overshadow this upbeat earnings report.
Noteworthy Strategic Items
Microsoft - The Elephant in the Room: I find issue with CTXS’s strategic positioning in the market right now. They have positioned themselves as a technology leader in application services, especially in Windows based virtualization efforts. However, very soon they may come head to head with MSFT as a potential rival. Microsoft has made not made it a secret that their entrance into the cloud would include application virtualization. Combine this with the fact that CTXS relies on Windows for a competitive edge, and I am not convinced this relationship can hold up in the long term. Right now it is working but five - or even three - years from now I wouldn’t be so sure.
Acquisition Target: It has been whispered that Citrix could make a good acquisition target for a variety of firms with piles of cash that want to play in the cloud. Their technology would provide any larger company with the foundation to compete immediately with anyone in this market, and could also create synergies if combined with the right partner.
Insider Selling, CTXS 10b5-1 Plan Sales: Insider trading is generally not a leading indicator for stock performance. Executives need to sell stock for anything from liquidity to diversification, and since options make up a large portion of salaries for these employees, turning those into cash is a natural progression.
However, there is one type of insider selling that is generally considered a negative sign in the eyes of the market. That is the 10b5-1 plan. With this type of sale, you can enter into a transaction agreement, but then rescind that agreement even if you come across insider information. The SEC says that insider trading must involve an actual transaction of shares. According to InsiderMonkey, companies with large 10b5-1 filings have experienced abnormal negative returns of 70 basis points a month.
Valuation: Given the advantages Citrix still claims and their history of strong results, I have to be careful about handicapping them too much for strategic reasons that could change. Nonetheless, even using appropriate growth assumptions without any penalty for a failing relationship with Microsoft, I still can only justify a price floor of $34 and a ceiling of $55 for Citrix. This is around where they were trading in mid October 2010.
However, their abnormal returns over the S&P for 2010 were incredible. They have also recently been trading near their five year high (which is not a sell indicator, just a fact). Citrix’s growth in the coming years will be high simply because of the expansion of the cloud. However, I feel their technological moat is no longer significant enough to warrant such a premium. The erosion of technological superiority will allow competitors to leverage their solutions in a way that will eat at Citrix’s market share. The thought of an acquisition could be appealing, but that is only a whisper in the wind at this point in time.
Ratios: Their ratios are a mixed bag. From a liquidity standpoint, they look perfectly healthy. Their current ratio has been constant for the last five years and they hold no long term debt. They generate free cash flows in excess of five hundred million, and should be able to cover any short term obligations. Their margins and return ratios had been decreasing since 2005, but recovered slightly in 2010. Their profit margin was the most notable increase, moving from 11.83% in 2009 to 14.78% in 2010. I believe this is due in part to the growth of their technical services (40% in Q4 and 31% in all of 2010) which include consulting and technical support, traditionally high margin items.
From a relative perspective, their price to earnings is almost double what it was in 2008/2006 (~46 currently versus 24.2 in 2008 and 26.78 in 2008). However, their price to book and price to sales have increased at a less alarming rate.
Citrix is a great company. They have been aggressively repurchasing shares. They have growth potential, but that is coupled with some potential strategic roadblocks. I feel that investors have already cooked in phenomenal growth for the next five years into the price of this stock, and I cannot justify that price with my assumptions.
If there were to be a run on the stock, and it returned to October 2010 levels, then I’d be more comfortable making an investment. However, at the $67 price level, I think Citrix is too expensive.