Riverbed's Diversification Efforts Aren't Working

Summary

• Riverbed's revenue grew at a CAGR of 27.5% from 2009-2013. However, revenue growth has slowed drastically in recent years.
• The company's growth is being impacted by the decline of the WAN optimization market. The WAN optimization market is expected to continue to decline.
• Riverbed's application performance management revenue has started to slow despite strong market growth. This is due to Riverbed suffering from subpar sales execution.
• Management has grown ADC revenue in line with the industry's growth. Yet, Riverbed will have a difficult time outpacing the ADC market's growth due to a very competitive market.
• Riverbed has expanded into new markets. However, Riverbed is going to under perform due to poor sales execution, a declining mature market, and an intensely competitive market.

Riverbed Technology, Inc. (NASDAQ:RVBD) is a provider of WAN optimization, application performance management, and application delivery controller solutions. Over the last few years, Riverbed's revenue growth has been strong. From 2009-2013, revenue grew at a CAGR of 27.5%. Yet, Riverbed's revenue growth has slowed in recent years. In 2014, revenue growth was 6.7% for the first half and 5.6% in Q2. Additionally, revenue growth in 2013 was only 5.3% after removing OPNET's (acquisition) revenue contribution. Riverbed's slow growth is being caused by several factors. They have had trouble with sales execution especially in one market segment. The company's subpar sales execution is impacting their performance management revenue the most. The application performance management or APM market is expected to grow double digits but Riverbed's performance management revenue growth has slowed to the mid-single digits. The slow growth is despite having a top quality application performance management solution. Riverbed generates 72.3% of revenue from the WAN optimization market. Yet, this market has been declining and is expected to continue to decline. The company also supplies an application delivery controller or ADC. Riverbed's ADC revenue grew 6% in Q2 which is consistent with the overall industry's growth. Yet, Riverbed will have a very difficult time outpacing the ADC industry's growth due to a very concentrated market environment.

Market Growth

Riverbed operates in three main markets. Two of these markets are expected to grow over the next several years. The Application Performance Management Software market is expected to grow at a CAGR of 16.8% until 2018, according to Research and Markets. The Application Delivery Controller market is expected to grow at a CAGR of 8.13% until 2018, according to TechNavio. In Q2 2014, these market segments contributed 27.7% to revenue. These markets are growing fast but Riverbed is facing unique challenges in both markets. Riverbed's main contributor to revenue is their WAN optimization solution. However, the WAN optimization market has experienced a significant decline in recent years. In 2013, WAN optimization had a very volatile year. In Q4 alone, the WAN optimization market decline 8% y/y, according to Infonetics Research. In 2014, the market has rebounded slightly. In Q1 2014, the market grew 4% y/y but declined 8% q/q, according to Infornetics Research. Unfortunately for Riverbed, the recent down turn in the WAN optimization market is expected to continue. Inforentics believes the WAN optimization market will continue on its downward trajectory. As a result, the company's WAN optimization revenue growth will suffer. Can Riverbed's APM and ADC revenue offset the decline in WAN revenue and accelerate Riverbed's revenue growth?

Subpar Performance In The APM Market

The APM market is growing rapidly and Riverbed has a top quality solution. Gartner ranks Riverbed as one of the leaders in the Application Performance Management market. In late 2012, Riverbed strengthen their APM offering with the acquisition of OPNET. The addition of OPNET added $159.9 million to revenue in 2013. However, the OPNET acquisition was the main driver of 2013's revenue growth. In 2013, revenue increased a total of $204 million with $159.9 million directly from OPNET. Although total revenue grew 24.4%, organic revenue growth was much slower. Removing OPNET's revenue contribution, revenue growth was 5.3% in 2013. Management made the acquisition of OPNET to strengthen the company's APM product offerings. Yet, the acquisition has masked the company's underlying growth issues. OPNET's revenue is reported under the operating segment performance management. In 2012, performance management's revenue grew 48.3% and 234.5% in 2013. Yet, 2013's growth was skewed by the acquisition of OPNET. Removing OPNET, performance management's revenue grew only 5.5%. In the first half of 2014, performance management has continued its subpar organic growth even with OPNET's revenue. Performance management's revenue growth has slowed to 4.7% y/y. Despite Riverbed having a top quality APM solution, they are underperforming the industry and top competitors like Compuware Corporation (OTCPK:CPWR).

On Compuware's Q4 2014 conference call, Robert Paul CEO talked about fiscal 2014 APM revenue growth "...9% APM total revenue growth year-over-year." Compuware had strong APM revenue growth in fiscal 2014. Additionally, Compuware's APM revenue growth was 3% y/y in Q1 2015. Riverbed's 2013 organic APM revenue growth was well below Compuware and in Q2 2014 Riverbed fell short again. On the Q2 conference call, Ernest Maddock CFO talked about growth in their performance management segment "SteelCentral accounted for the remaining 22% of total revenue at $59 million, down about 3% from the prior quarter and up about 2% year-over-year." Riverbed's lack luster Q2 revenue growth was actually an improvement over the decline in Q1. On the Q1 conference call, Ernest Maddock talked about a decline in performance management revenue "SteelCentral revenue was down 9% compared to Q1 of last year..."

Management attributes the majority of Q1's decline to a very strong Q1 2013. Yet, performance management's organic revenue growth wasn't strong in 2013. Additionally, performance management's revenue in Q2 was down 3% sequentially from a very disappointing Q1 and only up 2% y/y. Riverbed is struggling to grow revenue in a market which represents a significant portion of revenue. Management could try to spur growth through acquisitions. However, management hasn't shown a desire to inorganically grow revenue. In the first half of 2014, they have only spent $1 million on acquisitions. Additionally, management has only made two major acquisitions since 2011. Riverbed will need to increase their growth organically. Yet in recent years, they haven't shown the ability to consistently grow organically. Management has simply been unable to execute and their growth has lagged the market. Additionally, Riverbed's failure to execute is also demonstrated by their sales and marketing spending.

Expense Growth

Riverbed has been unable to consistently grow organically. Yet, the company's failure to grow organically isn't due to a lack of sales and marketing spending. From 2009-2013, Riverbed's revenue grew at a CAGR of 27.5%. However, sales and marketing expense grew at a CAGR of 27.5% as well. As revenue increased, management aggressively increased their sales and marketing spending.

Annual Growth	2010	2011	2012	2013	2014
Revenue	40.0%	31.6%	15.2%	24.4%	6.7%
Sales and Marketing	26.8%	21.1%	20.5%	42.8%	-2.4%

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From 2010-2013, sales and marketing spending accelerated and reached a growth rate of 42.8% in 2013. Despite increasing sales and marketing spending, revenue growth has steadily declined. Riverbed's aggressive sales and marketing spending hasn't lead to increasing sales. Riverbed's subpar sales execution will continue to impact their operating segments. The company has a top quality APM solution but hasn't been able to grow double digits. Although, the WAN optimization market is declining, Riverbed will need to maintain or grow market share in order to keep revenue from drastically falling. Management needs to fix their sales execution problem and as shown above the problem isn't a lack of spending. Riverbed's sales execution problem should take a long time to fix. They will have to hire new management and adjust sales personal. This will be a big problem for Riverbed going forward. Yet even with better sales execution, the company will have a difficult time outpacing the ADC market's growth due to the current ADC market environment.

ADC Market Very Concentrated

Riverbed has expanded into the application delivery controller market. Although not a significant part of revenue, Riverbed's ADC revenue growth has been strong. In Q2 2014, ADC revenue grew 6.0% and accounted for 5.3% of total revenue. The company's solid Q2 grow was a continuation of strong Q1 growth. On the Q1 conference call, Ernest Maddock talked about ADC growth "...SteelApp ADC revenue was $13 million, up 7% compared to the first quarter of last year." Riverbed has been experiencing growth issues in their performance management operating segment. The operating segment is only growing mid-single digits in a market which is growing much faster. Yet, ADC revenue growth has been strong especially considering the maturity and slow growth of the ADC market. However in order to outpace the ADC market's slow growth, Riverbed will need to gain significant market share. This will be very difficult due to the dominance of the market leaders and strong 3rd and 4th place competitors.

The ADC market is very concentrated with F5 Networks, Inc. (FFIV) and Citrix Systems, Inc. (CTXS) accounting for an estimated 70% of the market. Additionally, A10 Networks, Inc. (ATEN) and Radware Ltd. (RDWR) are in a distance 3rd and 4th place respectively. The physical ADC market is well established and market share gains are very difficult. Yet, the virtual ADC market is more open. A virtual ADC is an ADC without any hardware component. The virtual ADC performs the same tasks but doesn't have a physical component. The virtual ADC market is expected to grow faster than the overall ADC market. However, the virtual ADC market is filled with physical ADC competitors. F5 Networks and Citrix have partnered with both Cisco Systems, Inc. (CSCO) and VMware, Inc. (VMW). These two vendors are going to be major supplies of the digital platform for virtual ADC. The third and fourth place competitors have both partnered with Cisco. Yet, Riverbed doesn't have a partnership with Cisco or VMware for their virtual ADC. This will put Riverbed at a significant disadvantage against the competition. Especially since, the ADC market leaders are already establishing their position atop the virtual ADC market. Citrix is considered the market leader in the virtual ADC market, according to Infornetics Research. The ADC market requires a competitive advantage in order to gain significant market share. Yet, Riverbed doesn't have an advantage over top competitors. This will be need to gain any significant market share due to the extremely concentrated nature of the market.

F5 Networks and Citrix both have top quality product offerings, significant sales and marketing efforts, more resources, and knowledge to defend their market share. The two market leaders' dominance even caused Cisco to exit the ADC market in 2012. A10 Networks and Radware only represent a small percentage of the ADC market. They have many years of experience and haven't been able to gain significant market share. Riverbed does have a quality ADC solution but they are facing a very competitive ADC market. Although, the virtual ADC market is more open. The top physical ADC vendors are using their market knowledge and leveraging their partnerships in order to stay ahead of the competition. Riverbed's ADC revenue has kept pace with the overall ADC market. Yet, the ADC market has been dominated by the market leaders for many years. These two vendors are fiercely defending their market position. Riverbed will struggle to gain market share in the ADC market which they will need in order to significantly increase total revenue.

Diversification Isn't Helping

Riverbed's main revenue source is from the WAN optimization market. Unfortunately, the WAN optimization market has been declining. The downward trend is expected to continued. Yet WAN optimization revenue represented 72.3% of revenue in Q2, management needs to better diversify their revenue. Over the last several years, management has been entering new markets. Management entered the application performance management industry which is expected to grow rapidly. Management made a strategic acquisition (OPNET) to bolster their APM offerings. Yet even with OPNET, performance management revenue growth has continued to slow. Performance management revenue grew 48.3% in 2012 and 5.5% on an organic basis in 2013. In 2014, performance management's growth has slowed even more reaching 4.7%. The application performance management market's growth looks promising but management has been unable to capitalize on this growth. Riverbed hasn't been able to capitalize on the application performance management market's growth but has done well in the ADC market.

In Q2, ADC revenue represented 5.3% of total revenue. Revenue has grown in the mid-single digits over the last two quarters. ADC revenue growth is keeping pace with the overall ADC market. Yet, Riverbed will need to outpace the industry's growth in order for ADC revenue to meaningfully contribute to revenue growth. However, the ADC market is very mature and dominated by two larger vendors. These two market leaders have an estimated 70% market share. They have driven larger competitors out of the market. Additionally, they are fiercely defending their market position. The battle for third place in the market is fiercely competitive with A10 Networks spending heavily and is slightly ahead of Radware. Although, the ADC market is expected to continue to growth. Riverbed isn't going to be able to depend on ADC revenue (5.3% of revenue) to be able to offset slower growth in other operating segments. Riverbed is a market leader in a declining market. They haven't been able to take advantage of a rapidly growing APM market. Although Riverbed's ADC growth has kept pace with the industry, Riverbed shouldn't outpace the ADC market's growth. Unfortunately, Riverbed's diversification efforts aren't helping drive growth. Riverbed's revenue growth issues should continue into the futures. As a result, Riverbed will continue to underperform.

Analyst’s Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.