Tuesday, June 26, 2012

Riverbed Buying Opportunity?

In a previous article linked here, I discussed the uncertainty inherent in the upcoming Riverbed $RVBD results and mooted the possibility that a decent entry point might be created out of them. Well, the results are in and, it looks like short term carnage for the stock price. However, is this time to be looking at buying and what should investors be looking for from the network gear maker?
A quick summary of the results
  • Revenues of $183m vs. estimates of $186.3m
  • Non-GAAP EPS of 20c vs. estimates of 20c
  • Q2 Revenue guidance of $193-197m vs. estimates of $202m
  • Q2 EPS guidance of 21-22c vs. estimates of 24c
At the last results, Riverbed predicted that revenues would be sequentially down 8-10% and, they 'delivered' by coming in at the low end of a 9.8% decline! Moreover, Riverbed previously confirmed full year guidance, but now, they are guiding toward a 15% rise in 2012 revenue. Market estimates were for an 18% increase. Gross margins were predicted to be flat in Q2, but profitability and margins were predicted to then rise through 2012.

Not only did Riverbed miss, but guidance was lowered for the full year. However, and this is a key point, the full year guidance implies that the second half will track what Riverbed previously predicted. Investors have the right to be skeptical about this.


What Went Wrong?

There are four issues, listed in terms of what I think their importance is. Firstly, signs of slowing government spending. Secondly, weakness in European enterprise spending. Thirdly, competitive encroachment. And finally, the sales disruption caused by new product launches and upgrades.

Government spending was 13% of revenue in quarter, which is seasonally usual. However, the big marginal shift in Riverbed’s government revenues occurs in Q3. The current management narrative is ‘upbeat’ over interest and conditions are seen as ‘normal’. In terms of US Federal spending, this seems entirely plausible for this year, as any efforts to reduce public expenditure are likely to start in 2013.

Current European market conditions were described as ‘mixed’ and, in fact, Europe is doing well. A breakdown of regional contributions and, yearly growth here:

RegionShare of RevenueYearly Growth
Rest of World19%4%

Its notable how weak growth was in the Rest of World segment and, Riverbed is upfront about the need to make progression here. Nevertheless, there wasn’t particular weakness in Europe, so, it was hard to attribute the earnings miss to this factor.

Turning, to market share, there is a shift in that Cisco $CSCO is now Riverbed’s most dangerous competitor. Traditionally, it was Blue Coat, but that company has been weak over the last year or so and, Riverbed confirmed that competitiveness with Blue Coat had softened. With a market share more than twice that of Cisco, it is fair to assume that Riverbed is the bellwether rather than Cisco.
In any case, investors can see what some of Riverbed’s key distributors are saying in order to gauge the industry. For example, Arrow Electronics $ARW was responsible for 17% of revenue with Avnet coming in at 10%. Arrow gives results on May 1 with Avnet reporting on April 26.


If it Ain’t Broke then Don’t Fix it

I think the key culprit is the disruption to sales patterns caused by the new product launches and the upgrades to the core Steelhead offering. Such things are common occurrences in technology, whereby customers prefer to run existing technology until they can receive anecdotal or professional information on how the new offerings are working.

Similarly, resistance to undergoing the expense of an upgrade cycle is natural among customers who are happy with the existing technology. These things take time and, from an operational perspective, it will require a realignment of the sales force’s priorities.

New products include Granite, of which orders have already been received. A Steelhead cloud acceleration product was launched with Akamai $AKAM and although sales are not seen as material in the short term, it is a product with potential because it can be sold to existing customers in order to improve their SaaS offering. Akamai is the right partner for Riverbed because of its established customer base within content delivery.

New products, new challenges, but this isn’t just about products. When a company shifts from selling a core offering toward being a multiple seller of different products to different buyers, it needs a refocusing of sales initiatives and approach. In addition, much of Riverbed’s challenge is to educate customers over the advantages and return on investment (ROI) generated by WAN optimization. All told, you have a complex confluence of challenges to overcome. Sales cycles will inevitably be extended.

Realigning the sales structure and marketing effort is, as one analyst pointed out, not something that is typically sorted out in one quarter. This observation calls into question the management’s implication that guidance for the second half should be unchanged. In short, Riverbed is saying that Q1 was weak, Q2 has been lowered but, that the second half will be the same as previously thought. I’m not sure how the market will react to this.

Riverbed a Stock to Buy?

In a sense, investors are worried about another ‘Blue Coat like’ scenario, whereby a serious of excuses are given for gradually reducing sales growth and management undertakes umpteen restructurings and partnership agreements in order to turn things around. In Blue Coat’s case, nothing seemed to work. However, I suspect the key issue there was with product, not with operational concerns. Blue Coat had difficulties even though its competitors in the WAN optimization market were doing well.

For Riverbed, if the new products and upgrades are capable of generating ROI then there is no reason why the existing sales force – who were responsible for the previous excellent sales performance -- can't begin to accelerate sales of the right products to the right customers. I don’t believe good sales people suddenly become bad ones. However, they can become frustrated and de-motivated if their product line is not working. I think the real problem for investors is to discern whether the launches and upgrades have the appropriate traction in the marketplace and, unfortunately, the optics are being obscured by the transition.

Time will tell and Riverbed may well have to lower full year guidance in the next quarter. However, with the recent price declines the upside potential looks a little better and, provided this turns out to be a transitory issue for a few quarters, I think this could be a decent entry point.

No comments:

Post a Comment