CSFB JNPR: Providing Infrastructure For The Next Millennium (target:$200)
Paul J. Weinstein, CFA
Juniper Networks(JNPR)
Providing Infrastructure For The Next Millennium
Summary
We are initiating coverage of Juniper Networks with a Strong
Buy rating and 12-24 month price objective of $200. With its
addressable market growing at 100% and a pure play on the
exponential growth of the Internet, Juniper is a core holding.
Being the first to market with new generation of IP
infrastructure equipment, Juniper has the potential to be a "
category defining" company, as such we believe a premium
valuation is warranted.
Juniper's purpose built operating system, exponentially
higher forwarding rates and best in class software, provide
the underpinnings for a new generation of backbone equipment.
JNPR's time to market, high barriers to entry, technology
leadership & differentiation and enviable customer base are
formidable competitive advantages.
Price Target Mkt.Value 52-Week
07/20/991 (12mo.) Div. Yield (MM) Price Range
USD 138 $200 $0 None $7,010.4 $162-90
Annual Prev. Abs. Rel. EV/ EBITDA/
EPS EPS P/E P/E EBITDA Share
12/00E $(0.02) NA NA
12/99E (0.36) NA NA
12/98A (0.81) NA NA
March June Sept. Dec. FY End
2000E $(0.07) $(0.01) $0.01 $0.04 Dec.
1999E (0.15) (0.07) (0.09) (0.06)
1998A (0.11) (0.19) (0.28) (0.23)
ROIC (6/99) NA
Total Debt (6/99) $0.00
Book Value/Share (6/99) $6.37
WACC (6/99) NA
Debt/Total Capital (6/99) 0%
Common Shares 50.8
EP Trend2 NA
Est. 5-Yr EPS Growth 100%
Est. 5-Yr. Div. Growth NM
1On 7/20/99. DJIA closed at 10,996.1 and S&P 500 at 1377.1.
2Economic profit trend.
Juniper is a leading provider of Internet infrastructure
solutions that enable ISPs and other telecommunications
service providers to meet the demands resulting from the
rapid growth of the Internet. The Company's M40 routers and
JUNOS Internet software are currently used by several of the
world's leading service providers such as UUNet, Cable and
Wireless, IBM Global Services, Frontier GlobalCenter and Verio.
Investment Summary and Conclusion
Initiating coverage of a "category defining company" with a
Strong Buy rating
We are initiating coverage of Juniper Networks, a leading
provider of high performance IP-based routing switches, with
a Strong Buy, and a 12-month price objective of approximately
$200 per share. We believe Juniper defines a new category of
IP-infrastructure equipment suppliers that hold one of the
keys to unleashing the future power of the Internet. Over
the next decade, Internet traffic will grow several thousand
fold, in the process transforming the Internet into the
converged network that pundits have talked about for years.
In order for this to happen we believe two requirements must
be met: (1) performance must improve commensurate with the
traffic growth (i.e. thousand fold improvements) and (2) the
reliability, control, and scalability must match that of the
current voice network. Without these fundamental attributes,
there will be a mismatch between user expectations and Internet
capacity/capability.
Juniper is poised to address these requirements, specifically
at the core of carriers networks, a highly strategic position
where the worlds of copper, or electrical, and fiber, or
optical, collide. As the acceptance of IP gains strength at
the core of the network, carriers will increasingly look for
solutions that were developed specifically for their needs -
high performance, scalable for the future and compatible with
the existing infrastructure. Juniper boasts the industry's
first Internet-focused routing operating system, that not
only has the scalability and reliability that service
providers demand, but also is compatible with the existing
infrastructure (Cisco's IOS routing software) and delivers up
to a 10 fold improvement in price/performance over traditional
routing platforms.
Our primary reasons for recommending Juniper - franchise
potential, superior market growth, technology leadership,
strategic position in the network, high barriers to entry and
broad customer base
With the release of Q2 results last night, our revenue and
operating earnings/loss projections have already been
adjusted upward, see Exhibit 1, relative to our expectations
at the time of the IPO. Juniper's revenue growth came it at
75% sequentially vs. our anticipated 22% estimate. Q2
results showed gross margins at 54% vs. our 43%, owing to
higher than expected revenues and higher ASP's as the
existing customer base requested additional product interfaces
. Juniper was able to expand upon its diverse customer base,
bringing the total number of customers to 31, up from 22 in Q1
. Juniper has proven its ability to rapidly innovate its
existing software- releasing the third version of its
software in as many quarters. Our revisions reflect higher
revenues associated with a broader range of customers, and
higher operating expenses reflecting increases in R&D and sales
people.
The following factors make Juniper an attractive investment
at current levels:
Category Defining Company. Juniper is the first company to
come to market with a purpose-built, next-generation, hardware
/software solution designed for the core of service
providers' networks. As previous category-defining companies
have done in the past, Juniper has the opportunity to capture
a large share of the market opportunity from entrenched
competitors thus, Juniper represents a kind of call option on
the future of the Internet, and like other category defining
companies, deserves a significant valuation premium.
Rapidly Growing New Market Opportunity. As applications,
transactions and services migrate to the Internet, the core
infrastructure need to achieve unprecedented scalability,
creating a new opportunity. Enterprise routers, predicated
on a 100K user model, are not able to meet the challenge of
supporting 100's of millions of users upon which the Internet
is predicated. As shown in Exhibit 2 the market for Internet
backbone routers was approximately $169 million in 1998 and
is expected to increase to approximately $5.5 billion in 2003
, which equates to a 100% compound annual growth rate over
the next five years. We have conservatively estimated
Juniper's share at approximately 10% and believe there is
material upside to that assumption.
Real Products - Real Customers. Unlike its start-up brethren,
Juniper has a working product in production at the core of
several large carriers' networks, including the two largest
IP networking UUNET and Cable & Wireless in the world. With
the core team hired about 3 years ago, the first release of
software was shipped 18 months ago with hardware beta's begun
a year ago. In 1H:99 Juniper generated $27.6 mm in revenue
and we expect $48.3 mm in 2H:99. While Juniper's time to
market created significant distance between itself and
competitors, the high quality customer base is a testament to
Juniper's technological achievements/superiority. Having
shipped product to 22 customers, but only recognized revenue
from 8 as of 3/3/99, Juniper's pipeline of business is very
robust. For perspective, there are nearly 5,000 service
providers in the US, each of which has some potential to deploy a
current or future Juniper product.
Providing Infrastructure For The Next Millennium
Significant Barrier To Entry. The technology involved in
high end routing switches draws on expertise from multiple
disciplines (computing, silicon design, networking,
communications) which is what makes this a difficult market
to enter. Beyond that difficulty, the problems to be solved (
scale, speed, control, reliability) are new because the scope
of the network is entirely different. Finally, this task is
set against the backdrop of unprecedented rates of change and
exponential growth. Potential competitors will find the high
software content and custom designed silicon the most
daunting and time consuming tasks/attributes to replicate.
Development time and highly talented/experienced software
development team are viewed as the main barriers to entry.
Expanding Addressable Market: Juniper's market opportunity
will evolve both in product and customer opportunity, which
overtime will result in an expanding addressable market.
Today we estimate Juniper is addressing 35-55% of its
available market but within five years Juniper should reach
100% coverage. On the product front, we expect higher-end
platforms by 1H:00 that will provide hundreds of Gigabits as
well as higher-density aggregation and access platforms that
act as feeders to the core platform. Today, Juniper's
customer base is nearly entirely comprised of large ISP's but
in the near term they will target new customer segments:
first facilities based CLECs & IXCs, regional ISP, followed
by content providers, broadband access providers and finally
large corporate and govt. institutions.
Technology Leadership & Differentiation. Unlike competitors,
Juniper's software, JUNOS, has been field tested for
interoperability with existing software infrastructure (
Cisco's IOS), while incorporating the much desired MPLS
support. Amazingly, Juniper expects to have a major software
release every 3 months - virtually unheard of in this industry
. Juniper separates the routing and forwarding functions to
achieve enhanced performance and uses common chips and
software across all platforms/interfaces. Unique to Juniper
is the combination of a distributed shared memory &
distributed switch architecture, an extremely high speed
routing look-up engine, highly integrated ASICs and modular
software with a "clean-sheet" design.
Highly Experienced Management Team. The management team has
proven track records from internetworking, semiconductor and
computing companies including Cisco, Stratacom, Sun, Xerox
PARC, and MCI/ANS. Juniper's development team draws on
knowledge from three distinct disciplines -
telecommunications for traffic management, data networking
for IP forwarding techniques and computer systems for silicon
design, fault tolerance and clustering - providing a uniquely
deep talent pool for a start-up.
Valuation Metrics For New Age Companies
Valuation today is driven by scarcity value of unique ways to
play the New Public Network
As shown in Exhibit 4, Juniper is trading at 92/46x our
estimated 1999/2000 revenue, vs. our three comparable groups
- recent high-growth communications equipment IPOs, Internet
infrastructure companies and Internet destination companies -
are trading at revenue multiples of 32/18x, 54/31x and 27/17x
respectively. Many reasons exist for this premium, however,
in this market of rising tides lifting all boats, scarcity
value is driving up nearly all companies even tangentially
related to building the new public infrastructure. But when
the air comes out of this balloon, underlying competitive
attributes will dictate winners and losers, and based on this
factor, we would rather invest in Juniper than virtually all
of the other comparables. Our 12-24 month valuation target
of $200-plus is predicated on our belief that investors will
view Juniper as a true category defining company, one that
represents not only a claim on the construction of the
Internet, but also a claim on the market capitalization of the
incumbent vendors.
In viewing the historical performance of those companies that
were recognized as "category defining" companies, relative to
the performance of their respective incumbents (market
leaders whom they challenged), we hope to gain insights into
how to value Juniper's potential franchise. Our assumption
is that, today's valuations reflect two dynamic's (1)
investors are willing to accept private market risks (venture
capitalist risks) in the public domain, by funding companies
earlier than they historically have but (2) in return,
investors expect they will own a sort of "call option" on
particular market segment.
Future valuation will be based on Juniper's ability to be a
category defining company
As dislocations occur across the technology landscape we
believe new company's have a claim on the revenue potential
of an incumbent's existing market, a market that could be
radically transformed by the new company's technology. These
discontinuities are quite numerous including circuit to
packet migration, siliconization, optical networking,
broadband access, device and applications proliferation, etc
. In Exhibit 5, we have illustrated the historical
performance, measured in terms of market capitalization, for
those companies that have significantly outperformed the "
franchise names" in their respective markets. The pie charts
represent a relative view of valuation - the new comer's
market capitalization divided by incumbents' market
capitalization, first at the time of the new comer's IPO and
second the same quotient at today's prices. At IPO, all of
these companies represented a call option on the domain of
the incumbent's market opportunity. Those that were truly
category defining companies went on to capture a substantial
portion of the underlying market away from the entrenched
competition.
Removing the extreme case of Amazon, our selected group shows
, on average, that attaining a roughly 25% share of the
incumbents market cap is possible. If we examine Juniper
Networks in this light, we see that Juniper started off at
IPO with a market cap of less than 1% compared to Cisco.
This is not much different than Broadcom, which was less than
1% of Intel's market cap and now commands a 6% share.
Currently, Juniper is being valued at roughly 3% of Cisco's
market cap. If we assign this historic 25% percent average
to Cisco's market cap of $215 billion, the possibility for
Juniper's market cap could reach $50 billion over the next
several years. However, a 25% claim could seem aggressive -
for perspective, our revenue assumptions give Juniper a roughly
10% market share of the router market.
If we used 10% as the proxy for Juniper's potential market
claim, taking into account growth in the incumbents market cap
, over a competitive time frame and an appropriate discount
rate, we could establish a theoretical value for the stock.
Exhibit 3 illustrates this analysis under the following
assumptions - five year horizon, we use only Cisco's market
cap (assumed it can grow at 20% annually) and a 35% discount
rate. This yields a one year price target of $216 at an
expected share claim of 10% . While many of the assumptions
can be debated, the critical factor here is that a
substantial market opportunity and long term appreciation
potential exist. The fact that we have described this
analysis in terms of "call option" suggests significant risks
exists especially with regard to price volatility. With that
caveat also comes a reminder, in nearly all cases of the
preceding call option companies - letting valuation get in
the way of a sound fundamental story kept many an investor on
the sideline too early in the life of these companies. We advice
not making the same mistake with Juniper. |
