Blue Coat Q3 Earnings Write Up

Blue Coat $BCSI gave disappointing results which contrast unfavourably with Riverbed $RVBD, but might there be value in the share price? Blue Coat was originally written up in an in-depth article on this blog. The linked article should serve as providing the background to this update following results. In summary Blue Coat is a 'turnaround' story but as still to demonstrate that the company is on track.

The orientation of this blog is towards Growth at Reasonable Price (GARP) investing and so BCSI does not, as yet, seem to be a stock worth buying. However, for investors who favour special situations or value type investing than Blue Coat offers a more compelling proposition. Hopefully, some of the information here will be of use.


Blue Coat Q3 Results

The results were disappointing

• Q3 Revenues of $123.8m vs. $125.1m estimates
• Adj EPS of 34c vs. 36c estimates

As was the outlook

• Q4 Revenues of $121-128m vs. $129.8m estimates
• Q4 EPS of 32-38c vs. 38c estimates

Clearly, these are disappointing numbers and the stock sold off aggressively afterwards. Aside from the miss, what is peculiar about the results is that the analysts focussed on the performance of the Americas and Europe but completely ignored the Asian region in their questions during the conference call. This is bemusing, because the Americas looked ok (close to usual sequential decline) and Europe did ok. Asia was rather disappointing. The management said that the results were in line with expectations bar the Americas being slightly weaker than expected.


Regional Breakdown for Blue Coat Revenues

Before looking at the results in detail, it is worth nothing some of the points to look for in the results

1. Blue Coat is restructuring the European Sales operation having previously over relied upon Tier 2 distributors
2. Secure Web Gateway (core business) is a low growth business now as Blue Coat already has strong market share
3. Blue Coat's WAN optimization solution is generally seen as weaker than Riverbed's (who reported v strong growth) but has the facility to offer security as well. When customers want both than Blue Coat is advantaged

Turning to the regional revenue numbers (the numbers in red represent sequential declines)

Region	Q2 09	Q3 09	Q4 09	Q1 10	Q2 10	Q3 10	Q4 10	Q1 11	Q2 11	Q3 11
Americas	61,295	44,110	52,663	53,305	55,255	53,561	58,344	54,612	56,937	55,067
EMEA	37,586	43,905	39,731	41,735	44,952	50,531	47,924	42,207	40,889	43,755
APAC	20,143	21,581	21,228	20,931	20,229	23,024	26,325	25,661	23,221	24,060
Total	119,024	109,596	113,622	115,989	120,436	127,116	132,596	122,480	121,047	122,882

Source: Blue Coat


The Q3 Americas numbers look weak but actually there are in line with last years sequential decline (-3.3% vs. -3.1%)  and the European numbers recorded a sequential increase which might suggest that Blue Coat is over the worst of the company's troubles in Europe. However, Q3 is normally a very strong quarter in Europe for Blue Coat. As noted above APAC sales were rather disappointing and Q3 was only 4.5% above 2009. This is not particularly good given that this region is leading the global recovery.

Interpolating the historical numbers and making the following assumptions could give the following revenues for Q4

• Americas follows 2009 sequential increase, giving $60m
• Europe Q4 tracks same relative performance (against 2009) as Q3 did, giving $39.1m
• APAC YoY tracks Q3, giving $27.5m

This totals as a-conservatively put together-revenue forecast of $126.6m for Q4. The analyst estimates are for $129.8m but Blue Coat are guiding towards $121-128m. Either, Blue Coat is trying to under promise/over deliver or there is a fundamental weakness here.


Blue Coats Strategy

Essentially, the new CEO is trying to restructure the European sales operation and reduce its dependence upon Tier 2 distribution. As a consequence, Blue Coat held back from major lead generation attempts. However, the company looks set to accelerate customer acquisition activity following the hiring of a new CMO and expansion of a number of sales partner alliances with the likes of HP, Microsoft, Oracle and IBM. Whilst this process can be expected to take time -management are asking for 6-9 months- Blue Coat is selling into very favourable end markets.

The core web gateway security market may be slowing but WAN optimisation sales for competitors such as Cisco and Riverbed are soaring. It may well be that Blue Coat's WAN offering is not as competitive as it once was. For example Riverbed are claiming 43% share of the Advanced Platform WAN Optimisation market and are releasing new products (Virtual Steelhead and Cloud Steelhead) which enable the transition towards cloud computing. Similarly, Riverbed has just released 'Whitewater' which is a cloud storage accelerator that enables cost effective moving of storage to the cloud.

In conclusion, whilst Blue Coat is generating large sums of cash -see previous research- recent revenue growth has been weak and, the company is challenged to generate growth in its core market of secure web gateway. Nevertheless, it has the elements of a turnaround story and is favoured by strong end markets. For the value investor this may prove compelling.

For a GARP investor, it may make more sense to wait for confirmation that the Blue Coat product offering is not being fundamentally challenged. In the opinion of this blog, anything less than $126.6m in the Q4 revenue numbers will be a disappointment.