Citrix Systems: A High Margin Business With Increasing Free Cash

| About: Citrix Systems, (CTXS)
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Citrix (NASDAQ:CTXS) is an enterprise infrastructure software company with revenues of ~$1.1B and an installed base of 180,000+ enterprise clients. The SAM at ~2.7B grows at a rate of ~25% YOY.

Citrix sells into three product categories – app virtualization, app networking and online services. Citrix is mostly known for its application virtualization solutions. Application virtualization is a $1B+ market growing 10-15% YOY; Citrix is the market leader with ~$800mm virtualization revenue in 2006(75% of revenue). Virtualization brings in mostly license revenue with high 90% margins. Virtualization enables applications to run centrally at a data center, and be viewed remotely by users through dumb terminals. In a data driven world, it is critical to protect corporate data and ensure that only authenticated personnel can access or utilize the data. It’s also cost efficient to deploy applications centrally, for ease of IT management. Workers can enjoy a great desktop experience while avoiding many of the traditional disadvantages like theft, viruses, extended downtime, or having the rebuild preferences after a research cycle. This solution is particularly timely, as many customers consider their plans for migration to new Windows platforms.

App networking (10% revenue) represents a $1B+ market growing 30-35% yoy. App networking includes products like Netscaler, Wanscaler etc that accelerate applications in a LAN or WAN environment. Citrix competes against companies like F5 (NASDAQ:FFIV), Cisco (NASDAQ:CSCO) and Riverbed (NASDAQ:RVBD) in the space. Riverbed has the best Wanscaler in the industry – but they sell into the networking group within companies. Talking to IT managers at large corporations makes me believe that the Wanscaler market growth will be driven quite a bit by application groups; essentially people who get called when applications get slow. Hence this is an opportunity for Citrix in their embedded customer base.

Online service, which is 13% of revenue, is a $750mm opportunity with a 20-25% growth rate. Online service includes a host of applications delivered on a SAAS (software as a service) model. Products include GoToPC, GoToMeeting etc. Citrix competes with WebEx (acquired by Cisco) in the space –I believe WebEx is the high-end online meeting provider and Citrix is the SMB no-frills+low-cost provider.

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In short, Citrix is a market leader in the high margin virtualization space that’s growing annually at 10-15%. The Presentation Server [PS], a virtualization product, is the largest revenue component – 67% of total 2006 revenue, down from 75% in 2005. The PS brings in two streams of revenue - License and Update revenue.

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PS accounted for 71% of Software License revenue FY-2006. License revenue represents the PS subscription fee – it has an 80% renewal rate. Update revenue (called Subscriber Advantage or SA program) is a 12-24 month contract fee that subscribers pay to get subsequent product upgrades for free. 50-60% of the subscriber base has purchased the SA program. Renewal rates are at 70% for SA. The SA typically is 20% of the initial license revenue and constitutes 90% of deferred revenue. This is a high margin, high visibility revenue stream - the balance sheet deferred revenue component will keep increasing qoq through 2009.

Starting 2007, sales force will target the lapsed presentation server license customer base (clients who bought PS before and never renewed) which represents a potential opportunity of $400mm to $1B. Citrix also has introduced a new release of the presentation server at a higher ASP (5% ASP increase). The sales force commission structure has been tweaked to motivate people to sell higher revenue package by June 07. The combination of selling higher ASP products, increasing renewal rates in licensing, getting more subscribers to purchase the SA program and getting old clients back into the product will grow software license revenue 7% FY-07 and 08. SA revenue will increase 20% YOY in 07 & 08.

The market is fixated on the large presentation server revenue component that Citrix has. However, understand that this revenue component has steadily declined over the years, and will continue to do so going forward. This company has high margin revenue, low capex and will generate increasing free cash going forward. Citrix has ~$6B in market cap, ~$800mm in cash and has no debt. The company will generate ~1B+ in free cash over the next 3 years. Street estimates CTXS to do 1.307 and 1.487 in 07 & 08 respectively (I expect guidance to be upped quite a bit). I believe that the company will beat estimates for Q1-07. The momentum in SA revenue coupled with growth in networking products will bring about upward revenue revisions for 08. Citrix will earn $2 in 2008; I expect the stock to trade at $40, 20x 08-earnings. The stock currently trades at $33 ( 16x 08 earnings).

Disclosure: Author is long CTXS