NEW YORK ( TheStreet) -- It's fair to say investors have had excessive optimism with F5 (FFIV) for quite some time. Not only has this company traded at a valuation that is more than twice the P/E of rival Cisco (CSCO), but F5 has consistently demanded a premium above the industry average.
Granted, F5 has an excellent management team and has produced consistent double-digit growth. And the company has arguably superior technology in the growing application delivery control (ADC) market. However, this continues to be a story about valuation, and whether or not investors will ever get the returns that the current stock price presumes.
On Monday, the company announced that it had acquired LineRate Systems for an undisclosed amount. LineRate, which is a leader in software defined networking (SDN), should help strengthen F5's enterprise position against the likes of Juniper (JNPR) and also gives the company a possible entry into new areas to compete against new entrants, Palo Alto Networks (PANW).
Plus, investors should be encouraged by this acquisition, because although F5 has a 45% market share in the ADC market, recent earnings suggests that this market is beginning to slow. That the company missed both top and bottom line estimates was alarming, especially since rivals such as Cisco have begun to guide more optimistically, while making strategic investments to grow market share.Relative to expectations, F5's Q1 report wasn't a disaster. Nevertheless, the valuation suggests that the company should be posting higher than 13% revenue growth. The company did well growing service revenue by almost 30%. This is enough to outperform both Cisco and Juniper. But product revenue continue to disappoint, growing just 4% year-over-year and down 2% sequentially. The company clearly understands this weakness. And this certainly supports why F5 felt it had to acquire LineRate. I don't think F5 could avoid making these sorts of investments in the SDN market. The company needs a way to offset the soft product business or investors will question if the premium they are paying today is deserved.
As with F5, Cisco's hardware (routing and switching) business has been underperforming for quite some time. And upon realizing that hardware was no longer driving growth, Cisco has gone on a shopping spree, spending $1.2 billion for Meraki and another $141 million in cash for Cariden. Most recently, the company acquired BroadHop, a provider of next-generation policy control and service management technology for carrier networks.
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