Twas the day before Christmas 2014, and investors in F5 were already thanking Santa Claus! Over the past two months, their company, F5 Networks, Inc. (FFIV, Financial) had shot up, as if pulled by Dasher and Dancer, et al.
But Mr. Market is rarely as kind and patient as Santa, so F5 investors soon saw the price of their stock begin tumbling. It even gapped down, a month after Santa’s visit, when the company released earnings that failed to meet expectations:
After losing some $25 in January and February, F5 began clawing its way back up the chart. Yet, it’s still on GuruFocus’ Buffett-Munger list because of the price and because it has a 5-Star rating for earnings predictability.
So we have to ask, will Mr. Market continue to play the Grinch Who Stole Christmas, or will he now play Santa?
History
1996: F5 Labs, is established, its name inspired by the fastest and most powerful tornado on the Fujita Scale: F5.
1997: First product is a load-balancing program called BIG-IP. It directed traffic from one server to another when the original server was down or becoming overloaded.
1999: The company lists on NASDAQ as F5 Networks, at $10.
2000: The year of the dot.com crash; between January and December, F5's stock falls from $160 per share to $9.43 per share.
2000: As the scope of the downturn becomes apparent, John McAdam is hired as president and CEO. He immediately begins cutting costs and streamlining the product line, shifting the company’s focus from Internet startups to big brick-and-mortar companies.
2000 to 2014: Nine major acquisitions during this period.
2004: Introduction of TMOS (Traffic Management Operating System), which becomes the company’s core technology.
2010: Named as one of America’s 100 fastest-growing companies (number 64) by Fortune Magazine.
Unless otherwise noted, this section is based on information provided at Wikipedia and Company-Histories.com.
F5’s business
F5’s main area of business is in Application Delivery Controllers, or ADCs. The company says ADCs “...dynamically manage the flow of traffic between users and servers (physical or virtual), making multiple servers look like a single resource to the user.”
In addition, “...our suite of integrated product modules has expanded our addressable market into security, WAN optimization, application acceleration, policy management, and Diameter signaling and routing, where we compete with a growing number of companies not included among traditional ADC vendors.”
In its 10-K for 2014, F5 calls itself “...the leading developer and provider of software-defined application services.”
Its core technology is a software platform called TMOS (Traffic Management Operating System). TMOS ensures that applications are accessible over Internet Protocol (IP) networks, and that they are secure, fast and available.
F5’s application services, which are available as software modules, include:
- local and global traffic management,
- network and application security,
- access management,
- web acceleration and
- other network and application services
Hardware products include the BIG-IP family of appliances and a line of scalable VIPRION systems.
In addition to software and hardware, it offers a range of services that includes consulting, training, installation, maintenance and other technical support services.
Customers include companies in technology, telecommunications, financial services, transportation, education, manufacturing, and healthcare, as well as government agencies.
The company runs all of its operations as one segment; revenue breaks out this way:
International sales represented 48.3% of the company’s net sales in 2014.
Competition
Yahoo! Finance lists F5’s competitors as:
- Cisco Systems, Inc. (CSCO, Financial), market cap $149 billion
- Citrix Systems, Inc. (CTXS, Financial), market cap $10.6 billion
- Juniper Networks, Inc. (JNPR, Financial), market cap $10.9 billion
- F5 Networks has a market cap of $9.1 billionIndustry = Business Software & Services
The company believes competition is based on the following characteristics:
- product features and performance
- customer support
- brand recognition
- scope of distribution and sales channels, and
- pricing.
F5 notes some competitors are reducing prices in a bid to increase market share, but it thinks it can remain competitive without following them. It attributes this to high levels of customer satisfaction and brand awareness because of its products’ superior performance, functionality, and unique capabilities.
In fiscal 2014 the company spent $263.8 million on research and development.
Other
F5 Networks is incorporated in Washington State, and headquartered in Seattle, Washington.
At the end of fiscal 2014 (September 30) it had 3,834 full-time employees, including 1,054 in product development and 1,448 in sales and marketing.
Unless otherwise noted, the information in this section and the rest of the article is based on F5’s 10-K for 2014.
Comments: F5 Networks provides essential Internet networking products and services to large companies and governments. It had annual revenues of more than $1.7 billion last year and has been able to maintain its position in a competitive sector through product innovation and development.
Opportunities, Risks and Growth
Opportunities
With a history of successful acquisitions, F5 can look at future acquisitions as a source of new growth opportunities. In many cases this would involve broadening the scope of its offerings and expanding into adjacent markets.
Security, fraud detection, and related threats offer new opportunities for F5; its portfolio of products/services already includes a number of applications that help customers in their core and adjacent markets.
The company’s business development team monitors the market for opportunities to partner with other companies offering complementary solutions. Such partnerships open doors to new markets.
F5 also has a history of successful International expansion, which should allow it to build revenue globally, and especially as emerging markets quickly grow their technology sectors.
Risks
As the company focuses on larger business accounts, it adds new risk factors. For example, delays in recognizing revenue from just one account could hurt its operating results for a specific quarter or year. Growth in customer size also brings with it increased credit risks.
Its customer are moving to hybrid computing environments that involve cloud-based software and services that are accessed by way of smart client devices. Within this environment, pricing and delivery models are changing.
Some of F5’s competitors do what it is doing: making acquisitions and developing partnerships. This means competitors can offer more comprehensive solutions to customers in the space.
Innovation remains critical, as the company and its competitors race to develop new products and features. F5 needs to be able to offer the market the right products at the right time (as noted above, the company spent $263.8 million on research and development in the past fiscal year).
As an international company, it faces a wide array of risks, including the recent strengthening of the U.S. dollar against the currencies of countries in which it has operations. Internation exposure also includes country risks.
Growth
F5 Networks has demonstrated strong growth since its IPO in 1999. The following chart shows revenue (green line) and Earnings Per Share (EPS - blue line):
5 NeF
In its Annual Report for 2014, F5 notes
It has completed major upgrades to its core operating system TMOS, positioning it for growth with a number of major enhancements.
Similarly, it has completed what it calls a "complete refresh" of the BIG-IP appliance family.
As noted, it has developed a number of new applications to take advantage of growing interest in security products.
It recently added F5 Synthesis, described as, “a new architectural vision, consisting of three integrated components designed to address the needs of customers in today’s rapidly evolving technology landscapes.”
This section based on information in the F5’s Annual Report and.
Comments: A strong history of growth, a history that should continue with new and upgraded products. Risk factors do not appear to pose any outstanding issues of concern.
Management
President, Chief Executive Officer, and Director: John McAdam, age 64, has been the CEO since 2000. Prior to that, he had been General Manager of the Web server sales business at IBM.
CEO-in-waiting: Manuel (Manny) Rivelo, age 50, will be promoted from EVP of F5’s Strategic Solutions to CEO on July 1, 2015, succeeding McAdam. Rivelo has been with the company since 2011, and before that served as Senior Vice President of Engineering Systems and Operations for Cisco Systems.
Executive Vice President and Chief Financial Officer: Andy Reinland, age 50, joined F5 in 1998 as a senior financial analyst.
Board Chair: Alan J. Higginson, age 67, has been a director of the company since 1996, the year of its founding. He has also served as chair and CEO of Hubspan, Inc., an ebusiness infrastructure company.
Board of Directors: Seven independent directors plus CEO McAdam.
ISS Governance QuickScore: 5, a median score, on a scale that ranges from 1 (lesser governance risk) to 10 (greater governance risk). F5 receives two red flags, for Equity Risk Mitigation and Termination. It receives one green star for Board Composition.
Unless otherwise noted, the management and governance section is based on information at the company’s website and Reuters.com
Comments: The senior executive team has extensive experience with F5 and with the industry, and should be able to execute on the company’s continuing growth plans. Rivelo, obviously, will be new but should have another experience within and outside F5 to know the business and what it needs to do.
Ownership
Gurus: only one of the legendary investors followed by GuruFocus owns stock in F5: Joel Greenblatt (Trades, Portfolio), with 21,830 shares.
Institutional: according to nasdaq.com, institutional investors (mainly pension funds, mutual funds, banks, and insurance companies) own almost 98% of FFIV’s shares:
Short Interests: GuruFocus puts the short interest at just over 7%, and shows this history of short holdings:
Insiders: 1% of F5’s outstanding shares, according to GuruFocus, with the biggest holding by CEO McAdam:
Comments: The big money, institutional investors, have a solid investment in F5, as does its outgoing CEO.
FFIV by the Numbers
| F5 Networks, Inc. | Ă‚ |
| Number of shares in float | 71,280,000 |
| Number of shares outstanding | 72,140,000 |
| Price at close, May 11, 2015 | $126.28 |
| Capitalization | $9,109,839,200 |
| 52 week range | $100.73 to $136.11 |
| Trailing P/E (ttm) | 26.95 |
| Forward P/E (fye Sept 30, 2016) | 17.39 |
| Price/Book (mrq) | 6.84 |
| Price/Sales (ttm) | 4.91 |
| Return on equity (ttm) | 25.46% |
| Dividend in dollars (forward) | No Dividend |
| Share repurchases in fiscal 2014* | 4,700,000 |
| Share buyback ratio (fiscal 2014)* | 6.02% |
| Sources: Yahoo! Finance, May 11, 2015, * GuruFocus | Ă‚ |
Comments: The share price is about $10 below the 1 year high; strong ROE at 25 and a half percent; the company pays no dividend; and it had a strong year of buybacks in fiscal 2014.
Financial strength
F5 Networks receives an exceptional 9/10 for Financial Strength and 9/10 for Profitability & Growth; especially exceptional for a value stock:
We’ll review a few critical financial metrics, beginning with the company’s long-term debt. It’s one of the simplest charts we’ll ever see, no long-term debt now or in the past:
Next, a look at free cash flow, which has risen steadily since the company pulled itself out of the dot.com crash in 2000:
And, how about the company’s ability to generate steadily increasing earnings? Again solid progress since the dot.com days:
The GuruFocus system posts one Medium Warning Sign: Price is close to the three-year high:
- Current price: $126.28 (close of trading May 11, 2015)
- Three-year high: $136.11 (December 24, 2014)
- Five-year high: $143.21 (January 10, 2011)
Comments: No long-term debt, coupled with strong free cash flow and EBITDA, paints an encouraging picture of financial health for F5.
Valuation
F5 Networks was discovered on the Buffett-Munger screener at GuruFocus, thanks to its high predictability rating and a fairly low PEG ratio.
On the predictability side, the company enjoys a 5- (out of 5) Star rating because of the consistency and growth of its earnings. If we go the All-in-One Guru screener, and make a 5-Star predictability rating the sole criterion, we see only 125 names. In other words, out of the many thousands of stocks covered by GuruFocus, only 125 have a predictability rating that good.
Turning to the PEG ratio, we see it stands at 0.93 at the close of trading on May 11, 2015. The PEG, or PPEG ratio, is calculated by dividing a company’s P/E by the average growth rate over the past five years. A ratio below 1.00 indicates an under-valued stock; a ratio between 1.0 and 2.0 indicates fair valuation; and a ratio of more than 2.0 suggests a stock is over-valued.
At 0.93, F5 sits just below the fair value threshold; based on recent price action, and assuming investors bid the price up beyond the range of the past couple of weeks, F5 could soon be in fair-valuation territory. Of course, investors might also consider this price a resistance point and back away from the stock, leaving it to wither again.
Adding a little sauce to the situation is a report from Credit Suisse on April 29, listing F5 Networks as a potential buyout target (no further information is provided).
Comments: The current valuation seems somewhat low, and not only because of the PEG ratio. 5-Star Predictability would suggest this stock will get back on track again.
Conclusion
Notwithstanding today’s price action, I suspect Mr. Market will act like Santa in the long term. This company has lots of earnings horse- (or should I say deer-) power that should pull up share prices.
It undoubtedly will have more bad days, as news washes in and out of the market about currency exchange rates and technological developments. But in the long run, it may well be worth wrapping and leaving under the tree.
