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Should the Alarms Sound at F5 Networks?

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On the stock market, there is no shortage of growth stocks that are trading at high multiples. As a value investor, I often worry whether these stocks are worth the risk and can ever grow into their valuation. But also I wonder if investors will ever get the future returns they expect from paying such a premium today.

This has been my chief concern with F5 Networks. I've always wanted to like this stock but I could never collect the nerve to pull the trigger. On the heels of its most recent earnings report, I'm glad that I didn't.

Miss and Lower Guidance Very Alarming

For the period ending September, F5 reported net income of $67.7 million, or 85 cents per share on revenue of $362.6 million. Aside from a slightly higher tax rate, profits were somewhat unchanged from the year-ago quarter when the company earned $67.6 million and 84 cents per share. On an adjusted basis and excluding certain items such as stock-based compensation, the company earned $1.12 per share.

While this figure represents a 6 percent increase year over year, it fell short of analysts' estimates of $1.18 per share on revenue of $366.1 million. Essentially, although F5 grew revenue and earnings per share by 15 percent and 6 percent respectively, the company missed on both its top and bottom lines. Considering how tech companies have fared this year, including rivals such as Cisco Systems, this was not a huge surprise. But Cisco does not carry F5's high expectations either. If I were an investor, alarms would be sounding.

The company is producing product revenue growth in only single digits. Likewise, though F5 showed a slight year-over-year improvement in gross margins, that figure showed a noticeable decline sequentially. Similarly, investors have to wonder if growth of less than 13 percent in operating income supports paying the premium they would pay for these shares today.

Overall, the numbers were far from horrible. For the fiscal year, F5 earned $275.2 million, or $3.45 per share on revenue of $1.38 billion. While this performance can stand up against any other within the tech sector, the question is, does the stock make sense. With the recurring theme being weakness in IT spending, it doesn't appear as if things will get much better.

Moving Forward

The company was cautious in its projections for the coming year, but remained optimistic about its growth prospects. For the current quarter ending in December, F5 is expecting adjusted net income in the range of $1.14 to $1.16 per share, falling short of estimates of $1.20 per share. Likewise, the company's revenue projection range of $363 to $370 million also fell short of analysts' estimates of $373.7 million.

On the news, F5 saw its shares plummet 11 percent — reaching a new 52-week low of $81.07. It seems the company missed on earnings, while also lowering guidance was too much to bear for some investors — who have now decided to take a more cautious approach in expectations.

Combining F5's weak outlook with increased competition, I have to think this is the right stance. Aside from market leader Cisco seeing a resurgence, there are also the threats from Juniper Networks, Riverbed Technology, and new market darling Palo Alto Networks, which recently produced 90 percent year over year revenue growth.

Unlike many other tech companies that are dealing with weak IT spending, F5's challenge is twofold. Going in 2013, not only does the company face a challenge to produce growth, but that growth needs to come in sufficient quantities to justify the valuation. While management will never admit that they operate on pressures imposed by the company's stock price, this is also hard to ignore.

Bottom Line

The good news for F5 is it has some catalysts on the horizon, including a new product cycle that should be coming out next year. The bad news is the stock is now down over 20 percent on this current year and making new lows.

Is it time to buy? As promising as this may sound, I'm still not willing to pull the trigger here — not with the price-to-earnings ratio still twice the multiple of Cisco.

F5 is a solid company with an excellent management team. The company continues to log quarterly performances that speak to its sound business. But this continues to be a story about valuation.

With guidance having come down and revenue growing at a slower rate, the prudent play here would be to wait a couple of more quarters to see how IT spending rebounds. The risk in the stock is still too great.

—By TheStreet.com Contributor Richard Saintvilus

Additional News: F5 Networks Sees Weakness Spilling Into 2013

Additional Views: Is It Time to Consider Time Warner?: Saintvilus

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Disclosures:

At the time of publication, Richard Saintvilus held no position in any of the stocks mentioned.

Disclaimer