An Upgraded Product Portfolio Re-accelerates F5′s Growth

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Posting $406 million in revenue, F5 Networks ( FFIV ) exceeded its own guidance for Q1 2014. (Fiscal Years end with September.) Driven by increasing demand for its new hardware and software products, the company witnessed a 2.8% sequential and 11.2% annual growth in its top line. Strong demand for its upgraded product portfolio, positive customer response to the recently introduced Synthesis architectural vision, and F5′s 'Good, Better, Best' pricing model (introduced in November 2013) led to strong sales across all geographic regions. However, the higher proportion of service revenue lowered F5′s gross profit a bit  from 82.2% in Q1 2013 to 82.1% in Q1 2014.

Based on the rising demand of its new products, the growing strength in its security offerings, and the building growth momentum with its Traffix Diameter solutions, F5 feels confident of witnessing a continuous growth in its top line for the rest of 2014. It plans to continue introducing significant enhancements and world-leading technology in its key areas of focus, mainly security, service providers and mobility, the cloud and software-defined application services.

While we agree that the weak macro environment can restrict its short term growth, we believe in F5′s long term growth potential. Our price estimate of $112 for F5 Networks is at a 15% premium to the current market price. We are in the process of updating our valuation.

See our complete analysis for F5 Networks here

Rising Demand For New Products & Software Accelerates Growth

The product refresh last year has significantly increased F5′s sales momentum. In Q3 2013, F5 completed the launch of what it claims to be the most significant product refresh in several years. It developed a range of new products and software solutions with an aim to boost demand and create new revenue growth opportunities. New platforms include a high-end VIPRION 8-slot chassis and a new range of appliances, the BIG-IP 2,000, 4,000, 5,000, 7,000 and 10,000 Series. F5 also introduced the largest portfolio of software virtualization products and a new centralized management platform, BIG-IQ.

F5 claims that it has improved product revenue growth in fiscal Q1 2014. The new product line has equipped F5′s sales force and partner channel with the most functional and competitive ADC (Application Delivery Controller) solutions in the market and already accounts for the majority of the company's ADC sales. The ADC market is estimated to grow at a CAGR of 7.07% through 2015. F5 is a leader in a ADCs with a market share in excess of 50%.

F5 introduced its Synthesis architecture for software-defined application services in Q1 2014, and it claims that the architectural vision has been very well-received by its customers and channel partners. Synthesis helps customers improve service velocity and accelerates time-to-market through automated provisioning and intelligent orchestration of application services, which reduces the cost and complexity of deploying software-defined application services across all types of systems and environments. F5 also highlighted a number of partnerships with the leading developers of software-defined networking technology, which it believes will expand the market opportunities for its products.

Strong Sales Momentum In Security Solutions

F5 witnessed another quarter of strong sales of its security solutions, including ASM, APM and AFM modules, in Q1 2014. With the explosion of online data storage and processing and the rising number of remote and mobile users, security has become a major concern for most enterprises. Some 92% of Forbes Global 2,000 companies reported data breaches in 2012. Thus, this is one segment bound to witness tremendous growth in the coming years. The traditional firewall market is currently valued at $2 billion.

F5 entered the Internet firewall market in February 2012 and since then has expanded its security solution portfolio with the addition of new products. Its security portfolio solution has increased dramatically in the last few quarters. It acquired Israel based Versafe Ltd., a provider of web anti-fraud, anti-phishing, and anti-malware solutions in September 2013. Offering advanced web and mobile protection solutions, Versafe provides a comprehensive real-time detection and protection for every user, device and browser. The acquisition will help make the company's security, access, and mobile solutions (including its Application Delivery Firewall solution) stronger. F5 is building out two world-class security operations centers in Seattle and Tel Aviv to support the new online security service from its Versafe acquisition.

With the growing awareness of its security solutions in the market, F5 believes that this segment offers huge growth opportunity and expects the strong sale momentum to continue in fiscal 2014.

High Win Rates In Replacing Cisco's ACE Products

In 2012, rival firm Cisco announced its decision to exit the ADC market after losing more than 50% of its market share to F5 and Citrix. F5 has scored big product wins by replacing some of Cisco ACE products in large customer accounts in the last few quarters. It claims that competitive win rates continue to be extremely high. F5 recorded 900 ACE replacement project wins in fiscal 2013 and the company believes that the Cisco ACE install base continues to be a significant replacement opportunity for it, at least for 2 years.

The ACE installed base is over $1 billion, but F5′s target market is much larger.  In addition to replacing Cisco's existing solutions, F5 has the added opportunity of providing customers additional functionality including security, access control and application acceleration. Though Citrix remains a big threat for F5, we believe the latter will continue to retain its dominance in the ADC market.

Q2 2014 Outlook

- Revenue target of $408 million to $418 million.

- GAAP and non-GAAP gross margins to be flat sequentially.

- GAAP operating expenses in the range of $226 million to $233 million.

- Effective tax rate of 38%.

- GAAP EPS target of $0.87 to $0.90 and non-GAAP EPS in the range of $1.23 to $1.26.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Investing Ideas , Stocks , US Markets

Referenced Stocks: CSCO , FFIV , HPQ , IBM

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