Juniper Earnings Preview: Router Performance And Restructuring In Focus

| About: Juniper Networks (JNPR)
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Juniper (NYSE:JNPR) is expected to announce its Q1 2013 results on Tuesday, April 22nd. The networking company has done well in recent quarters, growing its revenues and operating margins on increased demand for core and edge routers. Last quarter, Juniper beat the high end of its revenue guidance by almost 4% and saw its operating margins expand to their highest level in almost two years. The revenue gains were driven by sustained strength in the service provider market as well as enterprise spending, which held up surprisingly well despite fears of federal weakness. Given that service providers account for almost two-thirds of Juniper’s top-line, we will be closely watching the performance of Juniper’s newly launched MX line of edge routers and the PTX supercore, which drove a 30% year-over-year (y-o-y) increase in order bookings last quarter. On the enterprise switching side, it will be interesting to see if EX and QFabric manage to sustain their strong performance from last quarter, when switching revenues rose by 36% over the prior year period.

The Q1 earnings call will also be the company’s first since it unveiled in February its “Integrated Operating Plan” to return $3 billion to shareholders over three years and cut $160 million in operating costs by Q1 2015. Following up on the plans, the company disclosed that it will reduce its worldwide headcount by 6% and dispose of around 300,000 square feet of leased facilities. As a result, it will record cash charges of $35 million in the first quarter of 2014 to account for employee termination expenses. It has also decided to discontinue the development of its application delivery controller (ADC) technology that it licensed from Riverbed (NASDAQ:RVBD) in 2012. The move is expected to have cost Juniper around $85 million in non-cash asset impairment charges in Q1. These one-time charges are likely to impact its near-term unadjusted EPS, but the company will be able to drive recurring cash savings going forward. Our $28 price estimate for Juniper is about 10% ahead of the current market price.

Data Growth Continues Despite Lingering Macro Concerns

With macroeconomic uncertainty beginning to subside, service providers have started investing more heavily in their network infrastructure. The recent macroeconomic concerns had caused project cycles to lengthen and extended the delivery timelines from customers. Capital spending on networks – and hence Juniper’s revenues – should continue to extend recent gains as economic conditions stabilize. This is because the macro concerns have had little impact on data demand, which has remained strong, driven by the key trends of mobile Internet and cloud computing. Specifically, mobile data traffic has grown massively with the proliferation of mobile devices such as smartphones, e-readers and tablets, and the advent of 4G. According to a recent Cisco (NASDAQ:CSCO) VNI report, mobile data traffic grew 81% in 2012 and is expected to grow at a CAGR of over 60% over the next five years. (Global Mobile Data Traffic Forecast Update, 2013–2018, Cisco, February 5th, 2014)

Service providers, who will need to buy networking gear to support the burgeoning demand for data, account for almost two-thirds of Juniper’s revenue. In the U.S., where service provider demand is on the rise, Verizon (NYSE:VZ) and AT&T (NYSE:T) are big Juniper customers, with each accounting for about 10% of Juniper’s revenues. The performance of Juniper’s new MX series of edge routers in recent quarters is perhaps the most encouraging, given that the edge router market is by far the biggest among all router markets. By our estimates, edge routers account for more than 50% of the overall market and about 70% of the service provider router market. Market share gains in the edge should therefore be the most accretive to Juniper’s value in terms of routers, which account for almost 40% of its overall valuation by our estimates.

Restructuring To Improve Cash Flows By $100 Million

Juniper has historically been an innovation-focused company, relying heavily on an expensive R&D budget to out-innovate rivals and gain market share. Its R&D costs as a percentage of revenues have generally been among the highest in the industry. Juniper’s R&D spend as a percentage of revenues of about 21-22% is about 9 percentage points higher than peers such as Cisco and F5 (NASDAQ:FFIV) networks. Reducing this to peer-average levels of 11-12% could drive cost savings of about $420 million in the longer run. Juniper’s plan to cut expenses by $160 million, on the back of the ongoing restructuring initiatives, is about 40% of that and can be reasonably expected to be achieved in the near term.

If Juniper realizes the planned cost savings by 2015, we expect its OpEx as a percentage of gross profits to decrease from around 63% in 2013 to about 54% two years out. Consequently, its EBITDA margins would improve by almost 540 basis points (5.4%). Adjusted for taxes, this could lead to an improvement of more than $100 million in free cash flow going forward. Our current estimates assume that the company will be able to implement its planned initiatives successfully and realize the aforementioned increase in cash flows as a result.

Disclosure: No positions.