Tuesday, June 12, 2012

What Riverbed's Results Will Reveal

This is likely to be a high profile week for network technology players in the cloud.  Riverbed Technology $RVBD reports on Thursday and investors look like they are in for the usual wild ride. Interestingly, fellow cloud technology player F5 Networks $FFIV reports on the day before, so Riverbed holders will want to see beforehand what F5 is saying about enterprise technology spending.
Riverbed is the market leader in Wide Area Network (WAN) optimization controllers, secure web gateway and application performance monitoring. Simply put, Riverbed's solutions optimize delivery of data by compressing, prioritizing and manipulating it. These areas set to be high growth areas in future, thanks to the explosion in bandwidth usage and the mission critical nature of the Internet with cloud computing.

In addition, WAN optimization provides a relatively quick return on investment and can generate growth even in slower economic times. Bandwidth isn't the only issue as the usage of business applications over the WAN isn't linear. In other words, WAN resources might be needed at unexpected times because bandwidth demand spikes can appear at random.

Blue Coat Systems is the main rival to Riverbed. In addition, the likes of Cisco $CSCO, Citrix Systems $CTXS and F5 Networks all play in this market, but they tend to offer specific or expensive large enterprise or data center solutions

Riverbed Technology appears to offer a superior solution to Blue Coat in terms of WAN optimization. However, Blue Coat's solutions offer an integrated approach which can incorporate security and performance measurement in 'one box'. If a customer wants an integrated approach, he will favor Blue Coat. For pure WAN optimization, he is likely to turn to Riverbed. It is incontestable that Riverbed has outperformed Blue Coat over the last few years and, the latter’s operational difficulties and poor performance has led to it being taken private.

What Should Riverbed Investors Look for in the Results?

 A few bullet points, of which, I will discuss in more detail below
  • How revenues and guidance are progressing with the launch of the new Steelhead platform and the new Granite hardware?
  • Weakness in the European outlook?
  • Potential competitive threats to their market position?
  • How Government spending is holding up?

New Hardware Releases and Upgrades to Steelhead

Steelhead is Riverbed’s core offering and, the company will be launching an option on a new platform as well as an adjacent hardware product called Granite. Consequently, at the last results Riverbed confirmed full year guidance but implied that Q1 revenues would be down 8-10% sequentially, which is a much greater decline than usual for Q1. The stock took a fearful hit after this announcement. Of course, this kind of guidance implies that the next three quarters will have very strong growth. Not only that, Riverbed predicted rising gross margins throughout the year. We shall see.

The truth is that there is always a lot of uncertainty about the timing of product sales acceleration with new launches and upgrades. Existing customers may decide to keep running the old system, or they may have been holding back the budget previously in order to buy the new system. Ultimately, who knows?   Riverbed management has done the job of downplaying expectations but the uncertainty remains.

Nevertheless, investors should listen closely to what management says in the conference call and, analysts will be sure to probe them on this issue.

Weakness in Europe?

Whilst the profit drivers of Riverbed are in strong secular growth trends, the company is not immune from slowdowns. In fact, the stock suffered last year when, in the Summer, it announced -in common with Fortinet and F5 Networks – that Europe was weak.

Riverbed described European sales as being ‘weaker than expected’ and, pointed the finger at its execution rather than product lineup. Strangely, they had cited Germany as being weak. However, all of this may have been due to the reshuffling of the company's European leadership in the quarter.
Nevertheless, I don’t believe in coincidences. Around the same time, F5 Networks talked of ‘weakness in some of the more macro affected economies in EMEA’ and, Fortinet mentioned ‘softness in EMEA from a macro perspective as well as timing of some of our larger transactions resulted in lower billings growth for the region’.

All three recovered but, then again, so did sentiment over the European sovereign debt crisis. Therefore, I think that growth for these companies is somewhat contingent upon confidence in European IT spending. Another thing to keep an eye on.

Potential Threats?

Riverbed is the leader in its field, but Blue Coat may make a comeback now that it has been bought out. Furthermore, Citrix and Cisco may also decide to compete more aggressively with Riverbed’s product range. They both have a WAN optimization product portfolio. Furthermore, F5 Networks may decide to take advantage of its position in application delivery to expand upon its WAN optimization offering.

This is perhaps, not something to worry about in the short term, but if Riverbed gives weak numbers –due to other factors- than it could look like they are losing market share. I doubt this would be good for the stock price.

How Government Spending is Faring?

Government sales make up one of the largest portions of Riverbed’s revenue generation. Indeed, in Q3 last year the company reported very strong growth due to this vertical. It is tempting to conclude that Riverbed is relatively immune from cutbacks because this is such a mission critical area of IT spending. However, cutbacks are cutbacks and because Government is such a strong vertical, it will only take a small marginal shift in Government spending in order to affect Riverbed.

What to Expect?

In conclusion, I think Riverbed is attractively priced right now but there is uncertainty connected to these results. This is a volatile stock and the slightest disappointment tends to send it tumbling. However, I suspect that the management has done a good job in downplaying expectations. Any significant earnings beat will send the stock rocketing.

For longer term investors, if they are prepared for how to interpret the upcoming results- and I hope this article is helpful- they might find a decent entry point into a company with excellent long term prospects.

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