Thursday, January 21, 2010

F5 Networks (NASDAQ:FFIV): Upgraded to Buy from Neutral at Merrill Lynch/BAC

Merrill Lynch/BAC is upgrading F5 Networks (NASDAQ:FFIV) to Buy from Neutral with an increased target of $65 (prev. $56). The upgrading comes following earnings out last night.

Firm notes they recently met management to discuss the opportunities and challenges for 2010. The meeting turned us more positive mainly on the expected strength of Viprion with telecom carriers, expected share gains in the core ADC market following recent product refresh and new significant opportunities in cloud computing and wireless segments. They also see limited risks to margins, which Merrill thinks will likely remain in the 32-33% range. F5’s quarterly results, reported last night, attested to the improving business momentum, leading them to increase their estimates, upgrade their rating to Buy and increase their PO to $65.

More value remains in the stock
Over the last 12 months, Merrill has increased the PO five consecutive times and remained cautious mostly on valuation. But the fundamentals keep improving, with revenue growth accelerating, competition getting weaker and new products and opportunities driving better growth rates and better margins. The company maintains one of the better growth rates in the industry (20-25% per annum) and one of the better margin structures (80% gross and 32-33% op). The stock was quick to trade up on the improving trends, trading up 137% last year, but we see additional upside. Ascribing a 23x target multiple (inline with industry levels) to their c2011 EPS estimate of $2.82, yields firm's new $65 PO. The stock is also supported by $8 in net cash.

Solid quarter and outlook
Revenues were up 15.5% YoY and 9.2% QoQ, with product revenues up ~11% and service revenues up 25%. In Merrill's view the improving momentum is also resulting in an increase in the deal size, with a large deal with a technology company signed last quarter and another large contract with a financial institution signed the quarter before. Operating margin grew from 25.4% to 31.7% YoY, and while they see limited additional upside to margins, sheer revenue growth should drive up EPS, in firm's view. On a fiscal basis, they increased their 2010/11 EPS estimates from $2.04/2.48 to $2.22/$2.68.

Accelerating market share gains
Firm expects F5 market share in the application delivery controller (ADC) segment to continue and increase, on the back of Viprion sales with carriers and a newly refreshed portfolio from several quarters ago. The company continues to extend its lead versus the competition, namely Cisco and Citrix, with relatively muted pricing pressure, which is mostly justified by its product leadership.

Opportunities within the cloud
Data center consolidation (cloud) is the leading opportunity for F5 core business. As customers scale up their data center and change the architechture, F5 sees an opportunity to offer the same level of its core application delivery, now across virtualized data centers deployed over multiple locations. Virtualization is the leading catalyst for F5’s momentum, and the company views its relationship with VMWare as strategic.

Classic ADC opportunities with wireless carriers
F5 is already in the Telco space, but mainly in the back-office. It is finding now new opportunities in the revenue generation-side to the telcos and mobile carriers. As the number of customer facing applications grows, carriers face server management issues, with a need to utilize F5 products in order to reduce the number of servers in the data centers. This is a classic functionality of F5’s ADC product, with years of similar deployments on the enterprise side. This new opportunity may therefore require very little R&D investment and could be accretive to margins.

Notablecalls: I think this call, helped by terrific earnings will drive the stock to multi-year highs. I see it up 2.5pts in the pre-market on very little volume. One can just hope it pulls back after the open enabling some decent fills.

It's likely headed to $56-$57 levels in the very near-term.

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