F5 Needs to Show More Consistency

NEW YORK (TheStreet) -- Business leaders are taught that any market considered worthwhile is assured of attracting plenty competition. In that regard, either the management at F5 Networks (FFIV) completely ignored this lesson, or worse, they underestimated their rivals.

With the stock trading today at around $95, the Street has staggered and impressed by F5's 6-month performance, which began after shares bottomed at a price of $67.53 last summer. The thing to remember here is in February 2013, F5 shares traded as high as $108 a share. Despite the company's 40% gains, shares are still down 12% in the trailing twelve months. This, however, should not be cited as a valid reason to buy the stock.

It seems investor are now trying to reconcile the direction of the company. Management still has not sufficiently outlined who and what F5 is. There continues some "misdirection" (I won't say confusion) within the company around next generation networking technologies such as software defined networking, an area where Cisco (CSCO) has begun to dominate.

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I can't forget that F5, even after it challenged Cisco by picking off LineRate, failed to exploit its market advantage in areas like application delivery control. This despite Cisco bailing on that market altogether and opening the door for F5 to rule the industry. Instead, F5's management failed to produce the sort of leverage the company needed to grow margins and seize market share. They couldn't shoot fish in barrel.


Granted, F5 has executed much better, helped by improved business conditions in the U.S. and Europe. It's also true that both revenue and profits have been on an upswing, leading to strong stock gains. Keep in mind, though, old habits are hard to break. And when the company reports fiscal first-quarter earnings on Wednesday, management must affirm that the Street's optimism is accurately placed.

The Street will be looking for earnings-per-share of $1.19 on revenue of $396.3 million, which would represent a year-over-year revenue increase of 8.4%. Given that F5 shares are now trading at a price-to-earnings ratio of 28 -- more than twice that of Cisco -- I don't believe anything less than double-digit revenue growth should be enough.

Investors who are stuck in the idea that "valuation doesn't matter" need to remember that everyone once in a while it does, especially for tech stocks that carry above-average growth expectations. Not to mention, this company lacks a strong track record of outperformance.

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Given the deficits F5 has had to work with, anything less than a beat-and-raise quarter will send the stock tumbling down. There's too much profit on the table as it is. For this stock to continue its uptrend, absolute results must impress and the company must raise guidance that beats and/or exceeds consensus estimates.

Management wasn't too hopeful entering this quarter. Although F5 beat both its revenue and profit targets last quarter, this guidance was reduced this time around. There's still a $6 million revenue gap between management's low-end projection for this quarter and what the Street wants to see.

Given F5's strong fourth-quarter, it's certainly possible that management was just being overly conservative with its guidance. It's also possible they could be telling the truth. Regardless, it will also be important for the company to demonstrate that it can offset the weak services business with strong sustainable product demand.

Despite one of the biggest appliance refreshes in the past four years, I'm concerned that F5 is still struggling with product revenue. And the feeble 1.2% product growth last quarter suggests either IT managers are still delaying purchases or the company is losing share to rivals like Citrix (CTXS) or Riverbed (RVBD).

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F5 demonstrated noticeable improvements, though the company still has plenty of work to do. And I believe management should begin by better diversifying the business to exploit the growth potential in both ADC and SDN markets mentioned above. Accordingly, the stock doesn't deserve a passing grade until F5 demonstrates it can deliver the goods on a more consistent basis.

At the time of publication, the author held no position in any of the stocks mentioned.

This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.

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