Weakness in European Technology Spending?

It’s been a good week for technology in general but three stocks stand out as being the big losers. Fortinet $FTNT , Riverbed $RVBD and, F5 Networks $FFIV have all seen significant declines. Why?

These companies have been written about on EarningsView. For example, Blue Coat Earnings Write Up , F5 Networks Growth Looks Solid , Fortinet Delivers Strong Results

What all three have in common is that they all reported weaker spending in technology in Europe and were on evaluations that appeared ‘stretched’ to say the least. I’ve decided to go through the conference calls and see what each said about Europe.

Company	European Commentary
F5 Networks	‘We have taken a fairly conservative forecast in terms of Q4 for EMEA as well. So, we are not looking for much growth sequentially there at all’…    …‘much like last quarter we saw weakness in some of the more macro affected economies in EMEA. Germany wasn’t great, UK wasn’t great. But the rest of the country did pretty well, excuse me, rest of the theater did pretty well.’
Riverbed Technology	‘Sales in EMEA were weaker than expected.. ..we attribute the softness both to the environment and our own execution’…  …‘Looking at Europe specifically, the weakness was in a surprising place, which is our central region headquartered in Germany, and Germany is supposed to have one of the stronger European economies. So that's what tells me there was some execution problem there.’
Fortinet	‘In terms of geographic breakdown of the billings growth Americas was at 32%, EMEA 2% and APAC 41% compared to Q2 2010. While Americas and APAC had very strong quarters, softness in EMEA from a macro perspective as well as timing of some of our large transactions resulted in lower billings growth for this region in this quarter. However, pipelines remain strong and we do expect to resume good growth in EMEA during Q3 and the balance of the second half.’…  …’ I don’t think it's totally ourselves, but what I’ve heard from some others that EMEA was, there was a little bit of malaise in EMEA, but that’s not an excuse, we think we will do better’

All three companies are leaders within their respective niches in technology and signs of weakness should be taken seriously. F5 Networks is a leader in application delivery networking, Riverbed is the top firm in the WAN (Wide Area Network) Optimization market and Fortinet is a global leader in UTM (Unified Threat Management) which is security solution primarily offered to small and medium sized enterprises.

European Macro Economic Woes Weighing on Technology

There is no doubt that firms in Europe have somewhat slowed purchasing decisions in response to fears over the macro environment and in particular European peripheral Sovereign Debt. I suspect this is a late quarter event because surveys up to June were indicating conditions that were holding up quite well in Europe. For example, here is the Optimism Index from Duke/Fuqua School of Business CFO Survey for June

Business Optimism Duke CFO Survey

Moreover, with regards to Riverbed we could be seeing the results of competitive pressures from the restructuring at rival WAN Optimization firm Blue Coat Systems International $BCSI. It will be worth seeing the results of Blue Coat because that company’s restructuring has been a long time coming.

Sovereign Debt Issues or Evaluation

I suspect, assuming a successful resolution of the European debt issues (Italy is the key) that these companies could report some upside surprise in EMEA revenues in the second half. So does this sell off in the stocks create a buying opportunity?

I’m not so sure and this view is principally due to the current evaluations. All of them looked stretched and were priced to perfection. In these cases, the slightest disappointment will see the stock price take a substantial hit. Even given the disappointing statements on Europe, these companies beat estimates and guidance was hardly weak, but it still leaves them on high evaluations.

Co	Stock Price	Q EPS Est	Q EPS Act	Next Q Guidance vs. Analyst Est	Current PE	Forward PE
F5 Networks	$101.5	91c	97c	97-99c vs. 98c	30.1x	28.7x
Riverbed	$32.3	21c	21c	21-22c vs. 23c	44.9x	36.3x
Fortinet	$21.3	8c	9c	9-10c vs. 9c	76x	59.2x

Frankly, I think the disappointment over the European statements is sending a warning over how highly rated these companies are. They are all attractive but, for now, these evaluations look a bit rich for me.

Check Point Raises Estimates

Check Point $CHKP gave results and both revenues and earnings were above consensus. Furthermore, Check Point raised revenue and earnings estimates for the full year, and the stock responded by crashing through a 52 week high. So is everything looking positive for the stock? I think it is.

Check Point was covered in an EarningsView research report linked here and this should provide some good background for the current results. Turning to these results a few key takeaways are

• Q3 Revenues forecast at  $300-308m
• Full Year Revenues Forecast raised to $1.23-1.25bn vs. a previous estimate of $1.19-1.23bn in January
• Full Year EPS forecasts raised to 277-284c vs. a previous forecast of 265-275c

Check Point Sequential Revenues

To put these numbers into context I’ve broken down the sequential revenues here.

 

(m)	Q4 08	Q1 09	Q2 09	Q3 09	Q4 09	Q1 10	Q2 10	Q3 10	Q4 10	Q1 11	Q2 11
Revenue	217.6	195.0	223.6	233.6	272.1	245.1	261.1	273.2	318.5	281.3	300.6
Seq growth %		-10.4%	14.7%	4.5%	16.5%	-9.9%	6.5%	4.6%	16.6%	-11.7%	6.9%
Cur Defer Rev	290.0	283.1	330.0	322.8	384.3	380.9	377.0	362.9	424.2	421.9	413.4
Seq growth %		-2.4%	16.6%	-2.2%	19.1%	-0.9%	-1.0%	-3.7%	16.9%	-0.5%	-2.0%
LT Defer Rev	40.8	41.9	32.1	37.4	41.0	38.9	37.7	33.4	40.4	38.6	43.5
Seq growth %		2.8%	-23.4%	16.4%	9.8%	-5.1%	-3.0%	-11.4%	20.8%	-4.5%	12.9%
Tot Defer Rev	330.8	325.0	362.1	360.1	425.3	419.8	414.8	396.3	464.6	460.4	457.0
Seq growth %		-1.7%	11.4%	-0.5%	18.1%	-1.3%	-1.2%	-4.4%	17.2%	-0.9%	-0.7%

Clearly, these results are good on a historically sequential basis and, it is no surprise that revenues and earnings forecasts were upgraded. Check Point is a relatively mature business that generates high amounts of cash flow conversion and provides investors with a compelling mix of value and growth. It is often compared with the likes of Fortinet $FTNT but Check Points end markets tend to be the larger enterprises who are in need of a comprehensive Network Security solution. In addition, the company is capable of scaling up margins and cash flow when markets are good because they offer a number of ‘blades’ with different functionality. In other words, once a company buys the platform from Check Point than they immediately become a potential customer for more blades.

Frankly, Check Point is the best in class in the sector and given continued global economic growth there is no reason why the company cannot continue to generate margin expansion. The main competition for Check Point comes from Juniper $JNPR and Cisco Systems $CSCO and with the latter in a stage of restructuring, for now, Check Point looks capable of growing market share. The question is whether the stock is correctly priced or not?

Check Point Evaluation

Turning to analyst estimates of EPS of $2.78 and $3.08 it seems that Check Point is set for low double digit growth in the next couple of years. At the current price of $59.3 (an EV of $11.43bn) Check Point trades on 21x and 19.2x earnings. Although, this seems rich, the high free cash flow conversion (around $684m) means that the share presents a compelling value proposition and I think there is a 15% upside potential to the price. A target price of $67.5 seems better value and I will wait for a dip before buying back in with that target in mind.

Kinetic Concepts gets Taken Over but Who is Next?

Kinetic Concepts $KCI announced today that they have agreed a $4.98bn takeover bid from London based Apax Partners. Naturally, investors will want to know what Apax see in this deal and which companies could be next?

Kinetic Concepts is the largest single wound care company in the world and despite flattish looking sales over the last few years, I think this is a very good deal for Apax. Not only is Kinetic Concepts highly cash generative but they have leadership in the negative-pressure therapy market. This is exciting because this type of vacuum treatment helps wounds heal quicker and reduces the amount of days that a patient spends in hospital. In turn this produces a huge saving. In addition, with the launch of a portable device it should be possible for patients to be treated at home and therefore generate more cost savings. With hospital budgets likely to be challenged over the next few years this represents a great opportunity for Kinetic Concepts.

 In addition, following channel checks, it has been revealed to me that Kinetic’s LifeCell division is generating strong demand for reconstructive tissue matrix product ‘Strattice’. So, in my view, Apax is picking up a company that is set for acceleration in its sales growth but which is already generating huge amounts of cash. It is a smart deal for them. So who is next?

Advanced Medical Solutions

I think a small UK company could be next in line. Advanced Medical Solutions is a wound care focused company that has an established wound care healing product called Activheal and a wound closure product that rivals Johnson and Johnson’s $JNJ Dermabond. I’ve spoken to a few surgeons and the general opinion is that Liquiband is pretty similar to Dermabond in efficacy. So, in reality, sales growth is likely to be generated via pricing and the strength of the distribution ability. In other words, it represents a perfect opportunity for a larger company to come in and accelerate sales growth.

Potential suitors not only include the likes of Apax (who could know merge AMS’ products with Kinetic Concepts sales force) but also someone like Kinetic Concepts UK rival Smith and Nephew. In addition, now that Kinetic Concepts has gone to private equity there could be more pressure on a private equity purchase. AMS’ main rival in the UK is Convatec which is a private company. AMS is cash generative, profitable and has good growth prospects as it tries to expand sales for Liquiband in the US. I believe, a company that could be bid for in future.

I sold my Kinetic Concepts position and hold Advanced Medical Solutions.

Weakness in China Telecom Spending?

In the light of the recent profit warning from Ixxia $XXIA I decided to take a closer look at what other players in the industry such as $ARX Aeroflex, Spirent and Anite are saying. In summary, there does appear to be some weakness in emerging market network infrastructural spending. However, this may prove temporary and, merely a consequence of some caution from OEM manufacturers in the light of macroeconomic concerns relating to Japan and Euro zone sovereign debt fears.  In addition, handset and wireless appear to be growing well, so a pick up later in the year is possible.

As a note of caution I have sold off my Spirent position but retain Agilent $A as the co is more focussed on wireless solutions and the division does not make up more than 17% of revenues. The next company to issue a statement is likely to be Spirent in the UK when it gives half year results on the 4^th of August.

Company	Date	What they said	Global Markets?
Spirent	4th May	‘Trading performance for the period is in line with the Board's expectations and continues the positive trend that Spirent reported in its full year 2010 results’.	‘We expect to maintain progress throughout the remainder of 2011’
Finisar	15th June	‘Despite the decline in revenues compared to the prior quarter, we were able to achieve non-GAAP gross margin of 34.2%, exceeding our prior guidance of 32% to 33%’	‘The sequential decline in revenues was primarily driven by soft demand from our telecom customers, particularly Chinese OEMs’
Anite	29th June	‘Network Testing's prospects have been enhanced by the Invex acquisition and its growing global presence. Its broad suite of products means that it is well set to continue to grow, albeit in the first half it is unlikely to exceed the very strong comparative period last year.’	‘While Network Testing's revenue in EMEA increased by 33%, to £12.2m, and in the Americas by 44%, to £5.6m, in Asia it declined by 9%, to £6.3m.’
Aeroflex	7th July	‘Delays in shipment approvals from and orders of test equipment by U.S. government entities have caused Aeroflex to reduce its estimated ranges of net sales and Adjusted EBITDA to $198 million to $200 million and $56 million to $59 million, respectively’	‘we had some major achievements this quarter, including record sales of wireless test equipment, our first significant order from a major global manufacturer of wireless infrastructure equipment for next generation LTE(A) TM500 products’
Ixxia	7th July	‘Total revenue for the second quarter of 2011 is expected to be in the range of $67.0 million to $69.0 million, below the company's previous guidance of $78.0 million to $82.0 million.’	‘Second quarter 2011 revenue was impacted by several factors, including lower than expected revenue from Asia Pacific and from certain large equipment makers, as well as orders received late in the quarter that could not be fulfilled in the second quarter’

Network Testing Heading for a Weak Quarter?

I think that it is not unreasonable to expect Spirent to report some softness in this quarter, although it is not clear whether this is the start of at trend or a temporary pause. No matter, I have sold my position and will await their update. Ixxia have confirmed what Finisar said last month so it does appear that Chinese OEM’s have held back on spending.

 I suspect this is a consequence of a reaction to the events in Japan or alternatively part of the same forces that are holding back China LED street lighting expenditure. The latter is a subject well covered on this blog. It will be interesting to see how these pans out with Spirent’s next statement. In view of the sustained weakness in China LED street lighting I have decided to be cautious here.

Alere Makes a Takeover Bid for Axis Shield

Axis Shield's Daiabetes Franchise is the Key Attraction for Alere

Axis Shield was today made subject to a takeover proposal by Alere $ALR which you can read linked here and the subsequent response of the Axis Shield board was to reject the offer in a statement linked here

Alere was formerly known as Inverness Medical and has form for picking up UK diagnostics plays on the cheap. For example, over the last few years the co bought out UK co's BBI Holdings and Concateno. Both were a natural fit as Alere owns the patents for horizontal lateral flow strip diagnostic tests. BBI provided Alere with reagents and assays which could be used to develop tests and Concateno (primarily a drug and alcohol testing company) allowed them to naturally expand the product offerings.

With regards Axis Sheild, this company was covered at great length by EarningsView an article linked here and please read this for more background. I think the deal makes good sense but mainly for the Afinion point of care tests. It will allow Alere to accelerate sales of this system in the US as it competes with Siemens DCA Vantage system. Alere should be able to develop new tests for the system and also be able to expand sales of Nycocard (a cheap less accurate point of care system) mainly to emerging markets. The main attraction of Axis Sheild's point of care solutions is in its diabetes franchise and this is a good opportunity for Alere.


What's in it for Axis Shield Shareholders?

I think shareholders should accept this offer. ASD management has disappointed before with delivering unsatisfactory performance. I like Afinion and much of what the co is doing, but the distribution division clearly needs to be sold off and Nycocard's revenues are subject to the uncertainty of the flu season. In addition, Afinion US sales have missed targets last year-despite the co's tone- and I question whether CRP testing really is a useful way to differentiate between viral and bacterial infections.

The overwhelming majority of infections are viral and doctor's already know this. I've discussed this with a few doctors and opinion is divided as to the merits of CRP testing for this reason. However, CRP testing is widescale and Afinion is generating impressive-albeit lower than forecast- sales growth.

I think it is a good deal all round as I think that taking Axis Shield (and particularly Afinion) forward from here is better done by Alere. We shall see.

Agilent's Growth is Driven by Strong End Markets

Agilent $A is a pure analytical and electronic measurement company that provides solutions to diversified sectors involved in industrial output. I like this stock because it combines diversified cyclical growth and a secular growth story that is dependent upon new product development and regulatory and legislative drivers.

Agilent has been very active in research and development over the last few years and is starting to see the benefits of this. Furthermore, this transformation has seen the company shift from relying on over 40% of its revenues from the semiconductor industry towards becoming a truly diversified company. It is highly cash generative and promises strong growth.  It's time to take a closer look.

Agilent's Profit and Revenue Drivers

The three main divisions of Agilent are broken up as follows

Agilent	2010 Rev (bn)	2010 Op Margin	Growth Rates	Market Size (bn)
Electronic	2.8	16%	4-5%	12
Chemical	1.2	23%	5-6%	10
Life Sciences	1.5	15%	5-7%	19

In addition, Agilent sees its end markets as growing at 5-7% over the long term but the opportunity looks larger in the markets (particularly life sciences) where Agilent has the chance to expand market share. This doesn’t come without risk because the academic and governmental markets (not for profit) within life sciences could come under funding pressure going forward. However, this makes up only 8% of total revenues with the ‘for profit’ sector (biotech/pharma co’s) making up 14% of revenues. In addition, within life sciences, Agilent is seeing strong growth from the shift towards generics and biologic. Furthermore, Agilent is wel placed to benefit from the movement towards Ultra High Pressure Liquid Chromatography (UHPLC) from High Pressure Liquid Chromatography (HPLC).

Agilent is well diversified with the largest single segment (industrial, computing and semiconductors) only making up 21% of current revenues. The second largest segment is communications which is driven by technological change and LTE rollout as well as China’s 3G expansion. Agilent looks well placed in many markets.

Emerging Market’s are Key to Agilent’s Growth

Agilent are well placed in emerging markets and all three of the divisions are seeing an increase in the share of their revenues coming from Emerging Markets. In addition, Agilent’s strong market position in Electronic Measurement Group (EMG) puts them in good stead as manufacturing production shifts increasingly out to Emerging Markets like India, China etc. The return in investment is higher in EMG than in the other two divisions but Agilent is more established in this sector.

It is a similar story with the Chemical Measurement Group whereby there is strong growth from Asia. In addition, global trends are towards increased awareness of food safety and environmental awareness, which is all positive for measurement solutions like Agilent.

Somewhat surprisingly, Agilent is also seeing strong growth in Life Science’s group from Asia and this division appears to be the most exciting for Agilent overall. In essence, it is an opportunity that is categorised by the chance to grab market share in a fast growing (probably around GDP+3%) sector which is driven by proprietary technological change.

Agilent Stock Evaluation

Agilent currently trades at around $51.66 which gives it a market capitalisation of around $18bn and $17.3bn in Enterprise Value. The company is highly cash generative with diversified revenue streams and has invested impressively in R & D over the last few years. I like the diversification and the opportunities for upside potential given the tendency for greater quality control in increasingly complex manufacturing and research processes.

Analysts have forecasts of $2.88 and $3.28 for the year to Oct 11 and 12 respectively from $2.00 in 2010.  However, as ever, this doesn’t tell the full story. Free cash flow generation over the last three years has been $600m, $280m and $497m respectively and I think it is reasonable to expect around $900m for the year to Oct 2011. This puts Agilent on a FCF/EV of around 5.2% and that is too cheap for a company growing earnings in the mid teens.

I bought some with a target price of $58.