Deep Dive on $FFIV

by Enis September 18, 2013 1:07 pm • Commentary

Welcome to Deep Dive corner.  It’s a new type of post for us.  We don’t plan any immediate trade on this stock (in today’s case, FFIV), but the stock interests us from a top-down perspective, so we wanted to delve into the details in preparation for a future potential trade.

FFIV caught my attention yesterday with its acquisition of Versafe, an Israeli internet-fraud prevention technology company.  While the small acquisition is not material to FFIV’s results, I became more curious about FFIV’s prospects, specifically given the expected growth in the internet security realm.

FFIV is a $7.5 billion market cap Internet traffic management company.  99% of its net product revenues come from the sale of its application delivery networking (ADN) product lines.  53.5% of its total net revenues come from such sales.  The large majority of the other half of its total net revenues come from service revenues related to those ADN product lines.

Essentially, FFIV products help large institutions (Fortune 1000 companies and governments) manage internet loads and network contingencies.  Its principal competitors include Brocade (BRCD), Cisco (CSCO), Citrix (CTXS), Radware (RDWR), and A10 Networks.  The company gets about 55% of its revenues from the U.S. and the balance internationally (split about evenly between Europe and Asia).   

FFIV has been one of the main outperformers in the internet networking sector since the internet bubble burst.  Its other large competitors have never recaptured their stock price peak, while FFIV handily grew revenues and earnings through the financial crisis.  It has clearly been a technology leader, and its acquisitions (like Versafe) are becoming increasingly focused in the internet security realm.

But what about the stock?  FFIV is a 20x forward P/E stock with expected EPS growth of 15% over the next 2 years.  The company’s revenue split has gradually been shifting from product to services.  From the recent 10-Q:

Screen Shot 2013-09-18 at 12.42.01 PM

While the company’s spiel is that the increased services revenues is a positive that indicates a captured, captive user base, I find it concerning that margins on services are going lower over the past year.

Screen Shot 2013-09-18 at 12.42.45 PM

If services are becoming an increasing part of the revenue mix, but are less profitable, then future earnings growth prospects might be too optimistic.  In addition, operating margins have moved lower as well, potentially indicating that the services revenues are more expensive to come by, and require more sales and marketing.

In short, FFIV’s long-term technical downtrend from its January 2011 high seems to confirm the difficult fundamental backdrop.

[caption id="attachment_30403" align="alignnone" width="600"]FFIV weekly, Courtesy of Bloomberg FFIV weekly, Courtesy of Bloomberg[/caption]

FFIV is trying to combat competition with increased innovation, and its past success speaks to its ability to perform.  But the continued drop in product sales is an obvious long-term concern for this former high-flier.  For now, I’d still be more interested in selling strength than buying weakness.