High Fives for F5 Networks

| About: F5 Networks, (FFIV)

F5 Networks (NASDAQ:FFIV) is a great example of how fickle Wall Street can be. In late December, early January it was the flavor of the month selling at $146/share, and on a valuation basis, traded at a forward P/E Ratio of 40 with an earnings growth rate of approximately 45%. That's not outlandish. However, in the 1/19/11 conference call, executives stated that revenues would be slightly below heightened expectations, and the stock has been pummeled. It closed at $94.50 on Friday. To say it's been in the penalty box would be an understatement; it's more like on the disabled list.

If you think its get up and go got up and went, you may be mistaken. F5 Networks is still alive and kicking. There's a lot of life left in the company and in the potential appreciation of its equity value. Benjamin Graham wrote that a stock can drop 50% or thereabouts for no justified reason, and although F5 Networks did miss on the revenues side because of seasonality issues, it's only selling at a 2011 P/E Ratio of 26 based on consensus earnings estimates on Yahoo Finance. With a PEG Ratio of under 1 and as the leader in their industry, I think this security deserves a closer examination.

I contend that corporations like F5 Networks have the technology of our times, at least in the IT space. If you go back 15 years, you'll remember that companies like Cisco (NASDAQ:CSCO), EMC (EMC) and Oracle (NASDAQ:ORCL) were doing all of the behind the scenes heavy lifting that made our lives so much easier. Investors were paid handsomely by betting on these organizations. It's not like these companies aren't viable anymore. They're still industry titans, but got very big and the law of large numbers has caught up to them in regards to compelling growth stories. It's the young upstarts like F5 Networks that are building the backbone for Internet 2.0 and have the growth to show for it. Cisco is F5's largest competitor and has a 3-5 year CAGR of 9% according to ValueLine. F5's CAGR is 31% over the same time horizon. Which company would you rather invest in?

According to its most recent 10-K: "F5 Networks is a leading provider of technology that optimizes the delivery of network-based applications and the security, performance and availability of servers, data storage devices and other network resources." This basically means it is in cloud computing. How big of a leading provider it is? The latest Standard & Poor's analysis reports: "Through constant share gains over the past five years, FFIV has garnered a dominant (number one) position in the market - about 50% as of the third quarter of 2010."

I recently wrote a post about Acme Packet (NASDAQ:APKT) and just assumed that it was a rival of F5 Networks. In doing research for this article, I have discovered that this is not necessarily true. Acme Packet and its Session Border Controllers disassembles, routes and reassembles data transmissions, which is a relatively unintelligent process. "By contrast, application delivery networking...requires intelligent systems capable of performing a broad array of functions," says the F5 10-K. These functions include load balancing, health checking (monitoring the performance of servers and applications) and encompasses a growing number of functions that have traditionally been done by the server or application. Acme Packet and F5 Networks work in tandem.

Application traffic management tools make networks less costly to manage and more efficient in traffic flow, particularly as the industry migrates to a more virtualized network infrastructure (to paraphrase the freshest S&P analysis). In that last conference call that caused the hemorrhaging in the stock price, CEO John McAdam articulates: "The market growth drivers for our business remains very much intact and include continued increase in storage requirements, global datacenter consolidation projects, growth in mobile and mobile applications, and increasing awareness of the importance and need for application security..."

ValueLine estimates that F5 Networks' addressable market will advance at a 20% rate out to 2013-2015 and that: "...its opportunity as the market leader appears to be quite lucrative if F5 continues to resonate with its customers." According to the 10-K, F5 plans to: "...continue investing in programs to promote the F5 brand and make it synonymous with superior technology, high quality customer service, trusted advice and definitive business value." I think that would resonate with clients.

To reach more customers and to compete against the likes of Cisco and other large competitors, it has developed strategic partnerships with enterprise software vendors such as Microsoft (NASDAQ:MSFT), Oracle and SAP (NYSE:SAP) to take advantage of already entrenched customer bases. With an R&D budget at 13.5% of revenues and plenty of patents, there's a lot to like about F5 Networks as a client or as an investor.

On the analyst side, there seems to be some contradicting impulses on what you should be doing in regard to F5. Out of the 34 analysts who cover the stock, only 18 have a buy or strong buy rating, while 13 have a hold, and 3 consider it an underperforming entity. Besides the most recent quarter that was a miss on revenues, there is the upcoming conference call on Wednesday, 4/20/11, to discuss the 1st quarter. There are concerns that F5's 7% of total sales that emanate from Japan will be on the light side because of the recent earthquake and aftershocks. This could put additional pressure on the stock.

If we look out to 2012, the consensus earnings estimate for F5 Networks is $4.34, which gives it a P/E Ratio of 21.6 for next year. That's a bargain basement price for a stock that is expected to grow over 30% in that time frame, especially for a market leader in a growth industry.

If this is the type of security that interests you, then it's your decision whether you want to pull the trigger on F5 Networks before Wednesday's 1st quarter conference call. My strategy is to wait because I believe this time in investing history is more like 1937, not 1997. My theory is that the markets are due for a considerable pullback and P/E Ratios will contract even more. However, when I do begin to purchase individual securities again, a company like F5 Networks will take a commanding position in my portfolio.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I am short the markets using inverse ETFs.