Is F5 Networks Still Overvalued?
It is not secret that I have been an unabashed cheerleader of networking giant Cisco Systems — which by default would make me a so-called “hater” of its chief rivals, including Juniper Networks, Riverbed Technology, and to a lesser extent, Hewlett-Packard. Who has ever heard of a Yankees fan that also roots for the Red Sox? It just doesn’t make sense.
But I have recently found myself secretly admiring the recent performance of one of Cisco’s chief rivals in F5 Networks, a company that I continue to consider grossly expensive by many standards — not the least of which stems from its price-to-earnings ratio of 42.
Be that as it may, F5 continues to log quarterly performances that suggest that not only does it have its act together, but more importantly, it consistently demonstrates to investors that it has no problem growing into its valuation — and its recent earnings announcement further affirms to the market that (just maybe) its growth expectations have not reached the level of “too high” as currently perceived.
The Quarter That Was
In its most recent quarter, the company reported revenue of $339.6 million — representing an increase of over 22 percent on an annual basis and 5.3 percent sequentially after having $322.4 million in the prior quarter. It earned $68.6 million in net income or 86 cents per diluted share. This compares to having earned $66.5 million, or 83 cents per diluted share, in the prior quarter. When one considers that its net income represents an increase of over 23 percent from the same period of a year ago, it becomes clear that this is one company that is heading in the right direction and not only does it have a sound business, but also it benefits from exceptional management. So what is the problem?
For me, regardless of performance, it is hard to fall in love with a stock that trades at such a high P/E of 42 that competes within the same sector as the market leader in Cisco that trades at 15 — or less than half the multiple of F5. Clearly, the company is executing in a manner that suggests that the market just might be right. However, from the standpoint of value and the fact that the company has already climbed 23 percent on the year, I can’t ignore the reality that I might have already missed the boat.
So, to make a case for F5 at current levels, I have started to look and skate to where I think the puck is going. And one such area happens to be cloud computing and virtualization — one of the high-demand areas that have contributed to the company’s recent stellar performances — to the extent it has more than doubled its revenue over the past five years. It’s also a contributing factor to its 5 percent growth above its first quarter results.
One of the company’s strengths, and one that I consider grossly underappreciated, happens to be its high-tech multiprocessors that provide corporate IT services to companies. It not only helps IT departments use off-site data storage, but also helps corporations exercise safety from the standpoint of data processing. There is also F5’s lead in the core ADC market — one where (according to Gartner) it has over 60 percent of market share, ahead of even Cisco.
The company also continues to position itself for mobility by its recent acquisition of Traffix, a firm that specializes in 4G Diameter signaling products for telecommunications service providers. This acquisition presents new growth opportunities for F5 — particularly in the mobile market as well as offering the company the ability to leverage and further its cloud packet-guiding strategies. What is clear is that not only does the company understand what the market is expecting in terms of growth, but also it has developed a comprehensible blueprint of how to get there.
I was broadly pleased with the company’s performance and from this point forward, I will no longer be just a closet admirer of one of the best stories on the market. As competitors such as Cisco and Hewlett-Packard continue to rebound from a disappointing 2011, I would think that this will only add increasing pressure to F5 to continue to perform. And I think the company understands this by having issued third-quarter guidance that arrived slightly below pre-existing estimates.
As enamored as I have now become with its performance, I still can’t see myself biting at $131 price tag with a multiple of 42. That said, for risk-tolerant investors willing to be patient, there may be 15 percent more upside to the shares — putting it at $150. But for value investors I would look to names like HP and Cisco — although not as dynamic, they do offer some safety, while providing decent dividends yields.
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