Company Focus
'Air-traffic' niche readies F5's sales for takeoff
F5 Networks has a cure for the Internet bottleneck and an impressive list of customers. Analysts expect earnings to grow, as long as F5's product base does, too.
By Michael Brush
If you are an investor who uses the Web, you're among those surfers who get ticked off the most by the "World Wide Wait."
But good ideas often come out of frustration. So you may have decided you would gladly buy shares in any company that could figure out how to speed things up. L I V E V O T E
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By now, this line of reasoning has probably led you into fiber-optic broadband investments like JDS Uniphase (JDSU) or DSL plays with decent earnings revisions like Paradyne Networks (PDYN). But their solutions for Internet traffic jams -- widening the pipe -- won't do any good if servers at the sites you want to reach get bogged down by too many hits.
That's why some of the hottest-selling fixes for these information superhighway snarls are coming from an underfollowed Seattle upstart called F5 Networks (FFIV). The company, which just went public last June, makes software-based appliances that serve as air-traffic controllers on corporate computer networks.
"This year, there is supposed to be the big rollout of broadband," says Donald Bisson, a portfolio manager who owns F5 shares in the Evergreen Small Company Growth Fund (EKAAX), which returned 75% last year. "If you have broadband, and it still takes forever to get a response back, then you know there is a bottleneck at the Web site's server or your ISP. F5 solves that problem."
F5 products do this by monitoring the load on a company's servers inside a network or around the world, and then directing incoming traffic to the servers that have the least to do. If you have clicked on icons at RealNetworks (RNWK), eToys (ETYS), MapQuest.com (MQST) or BigCharts lately, then your Web page request has gone through F5 products.
Downtime is money
As long as the growth in Internet traffic continues (and there is no reason to think it won't), then F5's impressive sales gains in the 100%-a-year range probably will hold up in the near term, too. Businesses want top-notch air-traffic controllers at their sites because downtime, after all, is money. It not only costs dollars, but brand equity takes a hit, and customers lose confidence in the site, as well.Start Investing Community
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"Some studies show that if consumers are stuck for as little as 20 or 30 seconds, they go to a competitor," says Rob Lam, an analyst who covers F5 for Bear, Stearns. "This is why traffic management is one of the most important technologies in e-commerce today." He estimates that the market for network infrastructure software will grow to $4 billion by 2003, when the niche in which F5 now operates will be worth $1 billion.
Lam thinks demand for F5 products should support revenue gains of more than 150% this year compared to 1999, and about 70% to 80% on average for the next three years. Analysts at Hambrecht & Quist expect earnings growth of anywhere from 70% to 90% a year during the same time frame.
F5 products
Here is a quick rundown of exactly what F5 offers. The company's biggest-selling products carry out what is known as "load balancing." As data packets arrive from the Internet, F5's appliances look inside and figure out which server is best able to handle the request at the moment. Then they send the packets on their way.
"Our products can do a lot of things at a high level of throughput that you can't do with a switch," says Robert Chamberlain, chief financial officer at F5. "A switch is a dumb device that can do one thing really well, which is move packets quickly. As soon as you ask it to analyze headers, it does not have the processing power, and it slows the switch down."
By far, F5's biggest seller is called BIG/ip. This manages traffic inside local-area networks, or those typically inside a single building or company. Introduced in 1997, it accounts for a whopping 70% of F5 revenue. The next-biggest seller is a distant second known as 3DNS. This carries out the same air-traffic control tasks across wide-area networks.
A third offering, called See/IT, monitors traffic patterns and helps network managers figure out when they need to add more servers. And Global/SITE, released in October, lets companies deploy content across all its servers with less fuss. "We were the first out with this," says Chamberlain. "Most people have used home-grown solutions."
Blue-chip customers
F5 sells to some of the bluest of blue-chip firms in cyberspace. In finance, this means Bank of America (BAC), Citigroup (C), Fidelity Investments and Deutsche Bank (DTBKY). Retail or service clients include Alaska Air Group (ALK), Best Buy (BBY), Playboy Enterprises (PLA) and Nintendo. Internet service providers who have signed on include PSINet (PSIX) and MCI WorldCom (WCOM). F5 products also are used by the National Security Agency, NASA and the United States Navy.
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The company has inked several deals with firms that either will resell F5 products or will use F5 technology in devices they sell. This list includes 3Com (COMS), Cabletron Systems (CS), Extreme Networks (EXTR), Exodus Communications (EXDS) and NTT International, a Japanese telecom company. Analyst Eric Zimits, who follows F5 for Hambrecht & Quist, expects good revenue gains in years to come as F5 "up sells" new products, like Global/SITE, into this established customer base.
Not without risks
Of course, there are no guarantees that F5 will close enough deals to keep growing at such a fast pace. One of the things investors want to see in stocks with good earnings revisions is some sort of "franchise" that serves as a moat to keep competitors out. Does F5 have this?
The company is well on its way to developing a brand name, and it has solid expertise. Chamberlain says F5 will use that to develop new offerings, like products that know how to give priority inside networks to urgent important traffic and applications. "We will look back in five years and say we were really in our infancy in 2000." Zimits agrees the company's ability to innovate serves as a barrier to entry, as do its solid product support and distribution channels. "If F5 can leverage its installed base of partners, then they can become the de facto standard," says Bisson.
Nevertheless, investors need to keep an eye on competitors like Alteon WebSystems (ATON) and RADWARE (RDWR), as well as the privately held HydraWeb, Resonate and ArrowPoint Communications. Should Cisco Systems (CSCO), F5's scariest competitor, decide to take a bigger interest in the field, there could be serious trouble. "If Cisco really wanted to dominate this space, they could," says Lam. "But Cisco is really not interested. They are interested in the $300 billion telecom equipment market."
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Another thing to watch: product concentration. F5 hopes to bring BIG/ip sales down from 70% to 50% of overall revenue soon. That's still a lot, but not unusual for a start-up.
While all these risks are real, F5's stock has sold off from its recent highs of about $160 in early December for other reasons. For one thing, only four analysts cover the stock and offer support. Then, there was a lockup release in December. More recently, there have been some doubts about whether F5 would meet estimates for the quarter, says Zimits. None of these factors is cause for concern, he says. "I feel quite confident about the quarter." F5 will report earnings after the close Jan. 25.
The recent sell-off makes F5 look like a relative bargain, compared to other Internet infrastructure stocks, analysts say. Trading at about 30 times calendar year 2000 sales, F5's price-to-sales ratio is at the low end of the high-octane Internet infrastructure group of companies like Altheon, Inktomi (INKT), Akamai Technologies (AKAM) and Juniper Networks (JNPR). Then again, given the altitude at which these stocks are cruising, even the air-traffic control skills of F5 might not be enough to offer safety should these high fliers correct.
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