Riverbed Technologies: Ray Of Sunshine In The Clouds

| About: Riverbed Technology, (RVBD)

The announced acquisition of DemandTec (NASDAQ:DMAN) by IBM (NYSE:IBM) on December 8th, underscores the jockeying of positions within the cloud computing space. Big-fish are buying the small fry such as a recent deal by SAP AG (NYSE:SAP) purchasing SuccessFactors (NYSE:SFSF).

Adding fuel to the fire was the December 9th news that Blue Coat Systems (NASDAQ:BCSI) agreed to be bought by an investor group led by PE firm Thoma Bravo LLC and including a unit of the Ontario Teachers’ Pension Plan.

Cisco’s (NASDAQ:CSCO) recent introduction of CloudVerse is also a new entrant to the cloud scene.

Another name we think highly of in the WAN (wide area network) environment is Riverbed Technology (NASDAQ:RVBD). They too could make an excellent acquisition target to a larger player wanting to guarantee their footprint in the cloud arena. Yet, the company also has a bright future as a stand-alone business. What’s to like?

Revenue growth has averaged 9.3% in the previous seven quarters. In its latest period ending Sept. 30th, sales grew 11.4% (qtr.-to-qtr.). During Q3, the company acquired Zeus Technology LTD and Aptimize LTD, expanding their products in the virtual application delivery controller market.

RVBD’s balance sheet is clean with receivables and inventory growth in-line with sales. Days-sales-outstanding in the latest period was almost 39 days versus an average 32.4 days during the prior seven quarters.

One knock to the balance sheet is a 21.7% spike to accounts payable in the recent quarter, which was almost twice the sales growth in the similar period. Average payable’s growth is 13%. Given the aforementioned acquisitions, this recent spike in payables is not worrisome, but investors will want to see payables moderate against sales in future quarters.

The acquisitions also elevated goodwill both as a percentage of assets (12%) and equity (17%).

RVBD Goodwill
(Click to enlarge)

Cash-Flow: The Merriam Report Dual Cash-Flow Ratio for RVBD declined to +6.934 in Q3 from a reading of +13.487 in the prior period ending June 30, 2011. This decline was significant enough to trigger “recent” and “confirmed” bearish signals in our model.

However, despite the recent regression, operational cash-flows remain quite healthy. That said we would like to see an improvement in the dual cash ratio going forward. This we believe should manifest once the recently acquired property plant and equipment contributes to RVBD’s future sales growth.

(Click to enlarge)

Accruals: Another concern to an otherwise decent earnings “picture” is management’s recent reliance upon accrual accounting in building the earnings report. Since Q4 2010, the accrual ratio has been rising steadily, ending Q3 2011 at +10.43%.

According to our model, an accrual reading greater than +5% is considered bearish. It is not unusual to see spikes in accrual accounting at fast growing companies, especially in technology.

However, investors may want to keep an eye on future changes in depreciation and other non-cash items in the statement of cash-flow. Any acceleration in depreciation or build-up of “deferred” items could potentially be a harbinger of future liquidity problems or an earnings surprise.

Summary: RVBD stock is currently trading 15% below our estimated fair-value price of $28.15 per share. While the growth prospects for this company look bright and the recent M&A activity within the industry heating up, we would caution investors not to get caught up in “speculative” bidding on these shares.

For example, the private equity led deal for BCSI looks at first glance to be a special situation. Revenues had been declining in the past year and an activist shareholder (Elliott Associates) held almost 10% of the stock. Perhaps private equity can help straighten things out.

RVBD also has “target” appeal, especially at its current discount to our $28 estimated fair-value. And as mentioned earlier, its future as a stand-alone enterprise is equally appealing. So, what’s an investor to do?

If we were espying RVBD as a takeover candidate, we would want to see synergies realized from the Zeus and Aptimize acquisition bear fruit first. Any potential complimentary (industry) suitor would likely focus on the cash-flow potential of a target company’s recent investments as opposed to “enterprise value”. Why?

Shareholders of a takeover company are sensitive to equity erosion and management teams are getting keener to this sentiment. If your management is wagging cash and/or stock (presumably appreciated in value) to a target company, equity owners (of buyer) want to know that new additions to the family will be accretive sooner rather than later..

Even a potential PE buyer would want to see their borrowing costs (leverage) covered by cash-flows of the target business.

The recent decline in RVBD’s dual cash-flow ratio combined with an incremental rise in its accrual ratio leads us to believe that a takeover in the “near” future is remote. Anything is possible in this market, but RVBD has a capable management team. If they can continue to deliver, a potential buyout would be frosting on the cake.

Traders may find opportunities between $23 and $26. Patient investors with a longer-term horizon might consider initiating partial positions on any pull-back to the $22 area; full positions at $20 or under.

Disclosure: I am long CSCO.

Additional disclosure: Sources: Edgar, Bloomberg, Reuters, merriamreport.com