Thursday, January 20, 2011

F5 Networks Growth Looks Solid

F5 Networks gave earning results and it was promptly met by a 20%+ sell off. I suspect that this stock price fall is more to do with valuations than anything fundamentally wrong. This is not another Cree! Firstly, I want look at the headline numbers.

In Q1 to December 31, F5 Networks reported revenues of $268.9m and non-GAAP EPS of 88cents per diluted share. This was against consensus forecasts of $270.6m and 83cents.

For Q2 they guided towards revenues of $275-280m and non-GAAP EPS of 84-86cents. The market had estimates $281.1m and 85cents.  

Moreover, the mid point of their revenue guidance ($277m) represents a 34.6% rise on Q2 2009.So a 20% sell off, because they are guiding for revenues to be light by $3.6m?  

F5 Networks Was Ripe for a Sell Off?

I think what we are seeing here is a reaction to the sharp move upwards we have seen in the stock. When stocks are priced to perfection, any slight sign of weakness will seem them punished. I’ve held this before and, got out a lot before it had a $140 handle. As to the conference call, the Co mentioned a bit of weakness in late October but then, claimed that it had normalised in Nov-Dec.

Frankly, I'm not surprised that the guidance didn't trump estimates. Analysts are forever stuck in a game of 'join the dots' which always leads them to over shoot at a cyclical peak. They follow the stock price, adjust estimates accordingly, then move it downwards when the price falls. Analyst are eternally trying to make a name for themselves by appearing bullish about a stock doing well. The key to investing is to price stocks out yourself and to do it based on fundamentals, not on how an analyst can best fit his estimates to the current stock price.

F5 Networks Evaluation

Now to the fundamentals, considering that 2010 was a year of economic recovery (albeit tepid) we can expect some slowing of the rate of growth in the economy in 2011. However, this does not necessarily translate across all industries. In the case of network application technology, I don't think we will see much correction.

Indeed, F5 are guiding towards a 36.4% growth in revenues for the next quarter vs. Q2 last year. Similarly, they have just generated $97.6m in free cash flow for the quarter. For the trailing year, free cash flow it is $328.6m. This is not the 'dot com' bubble. These companies are generating real earnings and cash flows and, based on 'old economy' metrics their prospects look good.

A quick look at revenues and gross margins...

Dec 31 2009
Mar 31 2010
Jun 30 2010
Sep 30 2010
Dec 31 2010
Mar 31 2011E
Revenue (m)
Sequential Growth %

Gross Margin %

 ...demonstrates the slowing sequential revenue growth. Note that the midpoint guidance of 3.2% sequential for next quarter equates to 13.4% annually.

I tend to be conservative with these issues and for this type of situation I would want to buy it on a current FCF/EV of around 3.5% with a view to upgrading when/if they confirm a stabilising in sequential growth rate.  This would give a current price of $110. Well worth monitoring.