F5 Networks Gets a Second Wind

| About: F5 Networks, (FFIV)
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Long-term shareholders of F5 Networks (NASDAQ:FFIV) have had a white-knuckled ride with this revenue-generating enterprise. Going back to the market bottom in 2009, it was selling for $18/share, then obtained security stardom by reaching $144 in mid January, 2011. No small feat. Investors got fat holding this company which manufactures load balancers that optimize the delivery of network-based applications. Think Cloud Computing and the build-out of Internet 2.0. This is not your father's Arpanet.

Although F5 Networks is a microcosm of the evolutionary expansion of the Internet, the stock closed at $71 on October 1st, 2011, a 50% decay in share price in only 10 months. If you were drinking the momentum Kool-Aid last Winter and, bought at the top, you probably got fleeced because the average holding period is now two and a half months. It had a P/E Ratio of 40 and only a 17% growth rate. If you go by the rule of thumb to liquidate growth stocks when their PEG Ratios go over two, then that would have been the time to sell. I'm primarily old-school and staunchly believe in earnings over hype.

Investors got squeezed because of three consecutive quarters that disappointed the powers that be. At 71$, it was priced for a doomsday scenario, and, couldn't get arrested. However, after a strong Q4 conference call on October 25th, the security is back in motion, closing at $113 Friday.

If we move past the previous hysteria in F5, we can get a good look at their numbers and see if investors will get bilked by buying the equity at its current price. According to Yahoo Finance consensus average earnings estimates, the company is slated to earn $4.42/share in the current fiscal year which ends in September of 2012. We're right of the beginning of that cycle, so I'll use that number to calculate the forward P/E Ratio of 25.5.

That's not too bad when you consider their 5 year compound annual growth rate is expected to be 21%. It gives you a PEG Ratio of 1.2. Not bargain basement but very reasonable. The laws of arithmetic would tell you to go out and buy this stock if you have both value, and, momentum leanings. But before you pull the trigger, let's take a look at some of the intangibles.

Going back to the Q4 conference call, CEO John McAdam states:

  • "We made significant progress in increasing our addressable market by delivering solutions to our core ADC platform in adjacent markets, including remote access control, optimization, and security".
  • "... we continued to generate significant revenues from our partnerships with large application solution suppliers, including Microsoft (NASDAQ:MSFT), Oracle (NYSE:ORCL), and VMware (NYSE:VMW), where the ability of our products to optimize the performance, security, and availability of mission-critical business applications is unparalleled."
  • "... our new ground-breaking iApp technology simplifies deployment of applications, enabling 10 to 100 times faster application delivery through the network."

Although this is a plus for F5 Networks, Mr. McAdam also makes comments about the worldwide economic environment: "As far as the outlook is concerned, it’s appropriate to be cautious about the global economic situation, and we remain committed to strong profitability. Clearly, there are numerous uncertainties present in the overall economy as we enter fiscal 2012. Obviously, as the current macroeconomic conditions weaken, then overall global IT spending could be reduced."

He reiterates his stance in the Q&A later on in the conference call: "... let me give you the caveats once more that we read out, which is in terms of the annual growth guidance that we’ve given. That is absolutely based on the macro economy staying in the same condition. If it deteriorates, by definition we will have issues there, so there’s no question about that."

Most of us are well aware of the difficulties facing the economies in the "civilized" world. Making a bet on a solid company like F5 Networks or any company for that matter is the level of your risk tolerance. My migratory dollars have gone to cash, but you may feel differently. That said, I like this organization and want to take a closer look at what may be in store for them going forward via the November 3rd, 2011, Shareholder/Analyst Call.

If the Shareholder/Analyst Call was a television transmission, it would be like a science fiction infomercial hosted by the F5 Networks' company brass. This is not a left-handed compliment. These are progressive thinkers, and they presented a 3-5 year plan that is not only F5's story, but the future of the entire Internet infrastructure industry. It's a lengthy document, 42 pages, and, I thought the company showed tremendous business acumen by demonstrating what may happen to server virtualization and data centers as we move onward.

According to the document, one thing is for certain and that is the Internet is going to be more powerful and more ubiquitous: "... there are about 4 billion devices connected to the network out there in various forms, looking out to 2015 going up all the way to 15 billion and then stretching out to 2020 estimated at about 50 billion devices. So you think about those electric meters and sensors and - so it's a lot more stuff than just mobile phones that are being connected to the network ... Intel (NASDAQ:INTC) is saying in 2018, that servers will be about 125x more powerful than they are today."

That may be a no-brainer to those that are familiar with the evolution of the World Wide Web, but what does it have to do with F5 Networks and their leading position in load balancers and application delivery? It means they are expanding from their core competency of primarily a hardware based business and are entering the software arena much the way that Apple (NASDAQ:AAPL) did. They even state that they are taking a page from the Apple playbook. That is not to suggest they are competing with Apple; they are in different sectors of the technology industry.

With the amalgamation of hardware and software, F5 will potentially be able to obtain a bigger piece of the pie by offering such services as optimization, remote access, file virtualization, and, application level security. With their penetration into the Fortune 500 at 64%, and, 52% of the Footsie 500, they have a very good chance to be last man standing in what appears to be a slugfest when liquid data centers try to virtualize everything. That 5 year consensus CAGR at 21% as reported by Yahoo Finance earlier may be on the conservative side if the company's expansion plans pan out. If you want to play the favorite, you might consider F5 Networks.

To avoid revisionist history, I'd like to point out that I wrote a previous posting on F5 Networks last April when the stock was selling for $95. I liked the stock then. I like it even better now, however, I am out of the market. That price of $144 it was selling at back in January may not be its pinnacle, but, the 52 week low of $71 may not be the bottom either. My bet is that there will be low-hanging fruit again in 2012, just like there was in 2008-2009. I am waiting for P/E Ratios to contract, like they did in earlier periods of economic strife. When I do put my money to work, I will probably be taking a position in F5 Networks.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I am short the market with inverse ETFs