Riverbed: An Undervalued Growth Stock PT. II

| About: Riverbed Technology, (RVBD)
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When I published an article about Riverbed Technology, Inc. (NASDAQ:RVBD) on August 20, 2013, I suggested it as a long candidate with a trailing stop loss starting at $13.32. The share price at that time was about $16.50. Well, Riverbed has failed to rally and has since declined to almost $14 per share.

At this point, the growth expectations of the market are even lower than they were back in August and with good reason. I do not think that Riverbed has a wide economic moat. Consequently, the firm faces stiff competition. Also, Riverbed shareholders are facing some writedown risks as the firm used leverage to acquire OPNET.

With that in mind, the growth estimates for this firm are too low. The market is pricing in growth well below the potential economic growth rate. But, I think the diversification of the business improves the investment worthiness of the company and makes customers more sticky. Consequently, I remain bullish on shares of Riverbed, but I think the best time to accumulate will be after the share prices begins to turn. In other words, from a tactical perspective, I can't get involved yet, but strategically the campaign is bullish.

Recent Developments

  • Kate Hutchinson, an accomplished marketing leader, was appointed chief marketing officer.
  • Traffic Manager version 9 integrates with SAP NetWeaver 7.0.

  • Riverbed announced it expanded its Whitewater cloud storage appliance family with the addition of new hardware models and upgrades to its operating system. The features and capabilities make the new Whitewater appliances a critical component for enterprises wishing to leverage the economical price and reliability of cloud storage options such as Amazon Glacier. Cloud storage, an infrastructure as a service, was one of the fastest growing areas of the as a service models.

Fundamental Analysis

Riverbed's revenues recognition policies are standard. The firm recognizes revenues on hardware and software sales, either of which can be sold on a standalone basis. There is also a services component of revenues. Support and services is the fastest growing component of total revenues.

The EDITDA margin is typically in the low-to-mid teens, which is good from an investment perspective. Also, Riverbed is operating cash flow positive with stock-based compensation and depreciation and amortization being substantial non-cash expenses.

Near term, Riverbed may face a softening information technology expenditure environment. Longer term, Microsoft may improve the performance of its applications and there may be improvements in the Transmission Control Protocol.

Additionally, I think a minimum cash balance policy of $500 million should be implemented for safety and investment purposes.

On December 18, 2012, Riverbed completed its acquisition of OPNET; the acquisition was done with financial leverage. I dislike acquisitions financed with debt because of the writedown risk.

The twelve trailing months cash flow from operations is just less than 15% above 2012 cash flow from operations.

Shareholder equity is trending higher, but return on equity declined recently on a lower net profit margin.

With the acquisition of OPNET, leverage increased, but the solvency and liquidity positions remain solid.

But, goodwill and intangible assets represented almost 60% of total assets at the end of the latest quarter. This means that a writedown of goodwill could significantly increase leverage.

Overall, I think the growth of the business is bullish for the valuations, but the financial position is weakened by the relative quantity of goodwill to total asset.

Valuations & Portfolio Management

Riverbed is trading in a bear market of primary degree, which should positively impact some of the price-based multiples. Further, Riverbed is in a bear market of intermediate degree. The share price may not have bottomed.

From a forward-looking perspective, I do not think Riverbed has a wide economic moat, but I think it'll remain a going concern for the foreseeable future.

On a time series multiplier model basis, I think Riverbed is undervalued; on an absolute basis, the multiplier model valuations are attractive. Also, relative to its 5-year average valuations, Riverbed is undervalued.

The intrinsic value using an adjusted average multiplier model valuation is $32.89.

Using a cash flows based model, the market is pricing in a growth rate well below the potential economic growth rate. If I apply a conservative estimate of the growth rate, assuming the narrow economic moat, I get an intrinsic value of $22. I could also see $27 to $31 per share as the intrinsic value.

In terms of estimated value, the low end is $22 per share and the high end is $33 per share; the current share price is $14.12.

The last time that I wrote about Riverbed the estimated value was $32 per share and the market price was $16.54.

The 52-week price target is $23.76, which is inside of the estimated intrinsic value range.

The compound monthly growth rate since March 2009 is 1.4%, which I believe is sustainable.

The return distribution is positively skewed and is not leptokurtic (lacks tail risk).

From a valuation and portfolio perspective, I am bullish on the common equity of Riverbed.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.