Gear Maker's Core Product Keeps It Growing, Even In Tough Times
Amy Reeves, Investor's Business Daily - Monday November 10, 6:24 pm ET
Buyouts always carry risks. Like when your target's market is about to melt down.
Such was the case when networking gear maker F5 Networks (NasdaqGS:FFIV - News) agreed to pay $210 million for Acopia Networks, a firm whose customers were mostly in the financial sector.
F5 announced the deal on Aug. 7, 2007, right before the subprime crisis and over a year before the banking sector went down in flames.
Not surprisingly, the new business hasn't performed as analysts had originally hoped. Yet the company has proved surprisingly resilient.
On Oct. 22, F5's fourth-quarter profit beat Wall Street's views, even as sales came up slightly short. Analysts polled by Thomson Reuters expect double-digit annual earnings growth through 2012.
Core Product
Much of the upside in the quarter came not from any new buys, but from F5's oldest product line. Founded in 1996, F5 long specialized in application delivery controllers (ADCs). These gadgets help manage traffic on a network by dividing the application workload among servers so that no server becomes overloaded.
In July, F5 released an upgrade of its core ADC, called BIG-IP. The new version sold so well that F5 couldn't ship all its orders in time. Company officials say that if F5 had fulfilled the demand before this month, it would have met the quarter's revenue target.
Chief Executive John McAdam theorizes that the rush came from all the improvements F5 has made.
"We spent a huge amount of time on the quality of the product," he said. "If you opened up the box, you would see far less moving parts -- only one board instead of two -- and no connecting cables. We took orders of over 1,000 of them, and only three customers had problems."
In addition to simplifying, the BIG-IP has added a lot of functions over the years, such as encryption, data compression and firewall protection.
All this is part of F5's strategy to become indispensable to the data center, McAdam says.
"Data centers have been consolidating in a big way," he said. "Servers are becoming almost commoditized. A lot of the intelligence is moving to the application area of the network."
The consolidation trend is evident in a newer, higher-end F5 product called Viprion. It has a chassis with room for up to four blade servers, so the techies can scale up their capacity while using the same "gateway" in and out of those servers.
F5 has some heavy-duty competition in this field, notably Cisco Systems (NasdaqGS:CSCO - News) and Juniper Networks (NasdaqGS:JNPR - News). But Pacific Crest analyst Brent Bracelin says F5 stands out because its platforms are so open to customization.
"If I'm an application developer -- say an Oracle (NasdaqGS:ORCL - News) developer -- I've created a large Oracle installation and I have my Oracle applications talking to my F5 appliance," he said. "If I want to rip out F5 and put in a Cisco (appliance), that makes it very difficult to do without impacting the application. That makes (F5's) products very sticky."
Given that overall tech spending isn't expected to grow in the downturn, F5 has to grow by taking market share. Part of that strategy is taking up more "real estate" in the data center.
That's where the Acopia buyout comes in. Acopia specialized in file virtualization, a method of storing data so it can be accessed from places other than its physical location. This leads to a more efficient use of storage space, since files can be moved to wherever there's room and can more easily be shared.
The role of Acopia's device, called ARX, is very similar in the storage world to Viprion's role in the server world, acting as a gateway in storage networks. Thus, F5 can expand its footprint in the data center without going wildly outside its core competency.
The only problem is that some of Acopia's customers no longer exist.
"Certainly that's going to delay the potential upside around what that business can do," said Bracelin. "But I'm still bullish that in the longer term it can become a key growth driver."
Fortunately, ARX is a comparatively small part of the business, drawing only 6% of sales in the fourth quarter. McAdam points out that the firm has also reduced its dependency on financial customers. Their share of revenue fell from more than 25% last year to 15% in the most recent quarter.
Economic Outlook
The macro environment is still pretty scary. Sales growth has been slowing since 2005, when the company bounced back from the last recession. Analysts expect the slowdown to continue over the next four quarters.
But they see profit jumping 90% in fiscal 2009. Part of the reason for this is that profit shrank in 2007 and for much of 2008, when F5 ramped up its head count by 48%. McAdam says the firm has now returned to its previous policy of tracking its hiring closely to revenue growth, thus bringing margins back to historic levels.
Still, even after the bounceback effect, analysts see profit rising 18% in 2010 and 44% in 2011. With positive cash flow and no debt, F5 seems ready to weather a recession.
"We think of F5 as a survivor," analysts at Wedbush Morgan Securities wrote in an Oct. 8 note.
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