Last week, network equipment research firm Dell'Oro Group announced that F5 Networks' (NASDAQ:FFIV) share in the Application Delivery Controller (ADC) market increased to 52% in the third quarter of calendar year 2014. F5 derives a significant portion of its revenue from the ADC market, and has been the leader in ADCs for many years. The core function of its products is load-balancing data that distributes Internet traffic evenly across multiple servers in a data center (either physical servers or virtual machines). The company reported its sixth consecutive quarter of record revenues from the ADC market, driven by recent completion of a comprehensive product refresh.
F5 closed its fiscal 2014 with a strong Q4 2014 (reported on October 29), where earnings surpassed Wall Street expectations and came in ahead of the company's guidance. For fiscal year 2014 (ended September 30th), F5 witnessed a 16.9% increase in its top line and 12.2% growth in its net income. The company anticipates another year of solid growth and profitability in fiscal 2015. (Read our Q4'14 earnings article)
Although the ADC market is expected to continue to grow in the future as well, the rate of growth is estimated to slow down to single digits. We believe that an upgraded product portfolio, a strong balance sheet, and a focus on expanding its footprint in key growth segments will enable F5 to retain its leadership in the market.
Our price estimate of $124 for F5 Networks is just slightly below the current market price.
The ADC Market Continues To Grow, Though At A Slower Rate
An ADC distributes workloads throughout a computer network, simplifying both the management of data centers and the delivery of resources across diverse networks. ADCs also enable applications to perform faster.
While the ADC market witnessed double-digit growth in 2012, the growth rate declined to 4% in 2013. The market grew by just 1% sequentially in Q3 2014. Despite the slowing growth, the ADC market continues to have immense long-term growth potential. According to the research firm TechNavio, the global ADC market will grow at a CAGR of 8.13% between 2013 and 2018. One of the key factors contributing to this market growth is the increasing workload distribution using ADCs. The global ADC market has also been witnessing the emergence of cloud-optimized ADC equipment. The Dell'Oro Group believes that the expansion of security features in the ADC platform has and will continue to drive demand in the future.
Additionally, even as the ADC market is slowing, the software ADC market is growing rapidly, due to the introduction of Software-Defined Networking (SDN). A software ADC is an ADC without dedicated physical hardware, which makes it easier for network administrators to manage large and complex networks. The combination of more data, increasing Internet access, and the addition of mobile users is causing problems for network administrators. Transparency Market Research estimates the SDN market will exceed $3.5 billion by 2018. The general adoption of the technology is still relatively low, but is expected to take off in the next few years.
Upgraded Product Portfolio & New Solutions To Help F5 Defend Its ADC Market Share
The ADC market is highly concentrated, with only a few companies having a significant market share. With a more than 50% market share, F5 is the market leader in the segment. Citrix occupies the second position, with an approximate share of 20%, while A10 Networks recently surpassed Radware as the no. 3 player in the ADC market. The search for growth has forced the companies to add additional features. Many vendors have added a web application firewall or a distributed denial of service defense solution (DDoS). F5 recently acquired Defence.net, a cloud-based DDoS vendor, to enhance its on-premise DDoS solution. Additionally, F5 now has a web application firewall solution which complements its ADC solution.
Last year, F5 completed the launch of what it describes as the most significant product refresh in several years. The upgraded product portfolio has significantly expanded F5's addressable market, and the company reports that it is witnessing record competitive win rates. F5 also completed its acquisition of LineRate Systems in February 2013, which it believes will broaden its application-focused ADC solutions and advance its leadership in ADCs.
At its analyst meeting last year, F5 mentioned that its installed base of users has a relatively older suite of ADCs in place, ranging from three to six years of service, and even longer in some cases. That means a refresh cycle has just begun gaining traction. Earlier this year, F5 launched a second wave of new software and hardware solutions, which offer new features across all product categories. Enriched product capabilities should continue to drive growth and strengthen its market position.
F5 has been working towards positioning itself as a leader in the rapidly growing software ADC market, which is in high demand due to the ever-increasing complexity and workloads of networks. It is spending heavily in the segment, and has partnered with VMware and Cisco, the top 2 SDN vendors, to leverage their ADC expertise in the software ADC market. F5 has also expanded its ADC offerings to include a web application firewall (WAF). The WAF market is expected to grow rapidly at a CAGR of 17.92% until 2018.
We believe that F5 Networks has the expertise, resources, and capital to defend its leadership in the ADC market for years to come.
Disclosure: No positions.