Riverbed: Rich Multiple Keeps Ratings Down

Analysts were jubilant Friday morning about networking equipment vendor Riverbed Technology (RVBD), but investors less so: the stock was down over 6% at $44.52 after the company Thursday night announced sales that nearly tripled to $54 million, and profit of 16 cents a share, which beat analysts’ estimates for $49 million and 12 cents a share.

Riverbed also forecast results for the current quarter well above expectations: as much as $61 million in sales and 17 cents in EPS, compared to an average estimate of $55 million and 14 cents.

R.W. Baird & Co.’s Kenneth Muth raised his rating on the stock to Neutral from Underperform. Although the stock is expensive at 72x next year’s expected earnings per share, Muth is raising his numbers for this year, to comply with an increased forecast from Riverbed, with his sales estimate rising by 10% to $225 million and his profit estimate revised upward by 20% to 62 cents a share. Nonetheless, he says the stock is fairly valued just above the current price of $44.85, at $46. Operating expenses, notes Muth, rose 5%, ahead of his estimate, though not as fast as the rise in revenue. Among his concerns, Muth notes operating margins may decline, as management implied, and he’s keeping his $350 million revenue estimate for next year while lowering his profit estimate to 66 cents a share from 70 cents. Of concern to competitors such as Cisco Systems (CSCO) and F5 Networks (FFIV), Muth says that “After conducting dozens of interviews with end users, we believe Riverbed currently has more market share and “mind share” than any other vendor in the WAN acceleration market. The company estimates its market share at around 50%.” Moreover, he expects that market to more than double next year to $560 million.

Goldman Sachs’s Brantley Thompson also has a Neutral rating on the stock, and a target even lower than Muth, at $42. Thompson says that on the plus side, “Competitive landscape remains strongly in Riverbed’s favor and the strong 90% win rate against Cisco continues.” His complaint is that taking out $2 million of deferred revenue that came through a special arrangement with another vendor, the company’s revenue of $52 million was actually below estimates of $54 million. Moreover, the company is going to have to continue to invest in its professional services business, which will keep its gross profit margin under pressure: gross margin declined last quarter by half a percentage point, roughly, to 70.9% (still seems pretty high to me). Interestingly, Thompson’s estimates for this year and next are way above Muth’s, at $244 million and $466.7 million in sales. He thinks the stock is worth only 46x his 2008 earnings per share estimate of 90 cents (excluding stock options expense).

Meanwhile, W.R. Hambrecht & Co.’s Ryan Hutchinson, calling Riverbed “one of the best names in our coverage universe,” reiterated his Buy rating Friday morning, with a price target of $56. Hutchinson says international revenue was the standout for the company, with sales outside of North America more than quadrupling in the quarter. Some lumpiness in deal sizes last quarter and in the year-ago quarter distorted the comparison in North American sales growth, he says, but factoring out those deals leads to a normalized 31% year-over-year growth in North America, which is what should be expected going forward, he says. Hutchinson is taking his valuation out to 2009, with a 45x P/E multiple of $1.25 (Hutchinson’s estimates for this year and next are similar to Muth’s and Thompson’s, with sales of $225.8 million and $347.1 million, respectively, and profit per share of 65 cents and 90 cents).

With Riverbed shares continuing to fall Friday morning, down as much as 10% at one point, I suppose it’s simple profit taking.

Addendum: I should note that Piper Jaffray & Janco Partners both downgraded Riverbed shares Friday on valuation. Janco Partners’s Cameron Cooke actually raised his price target to $50 from $45, while changing his rating to Market Perform from Outperform. The stock is fairly valued at a current 46x his estimate of $1.03 in EPS in 2008, writes Cooke, and third quarter softness won’t provide much upside from there.