F5 Networks May Catch Activist Investor Attention Amid Sector Consolidation

In the backdrop of industry consolidation and potential growth concerns, networking company F5 Networks ( (FFIV) ) could catch the attention of activist investors, according to company followers.

While Seattle-based F5 boasts of being a high quality business with a well-established, installed customer base, the asset is also undervalued because its growth profile is slowing, said Sanford C. Bernstein  analyst Pierre Ferragu, adding that growth is also slowing in a natural way for a cash-generative business that has nicely penetrated the market.

At the same time, F5 Networks is among the few firms left to be picked up in the IT security management sector that has consolidated partly amid activist pressure. 

Last month, Infoblox ( (BLOX) ) agreed to be acquired by Vista Equity Partners for $1.6 billion following pressure from Jeffrey Smith's Starboard Value. The sale of Infoblox came after Riverbed Technology was taken private for $3.5 billion by a consortium led by Thoma Bravo in 2015 after Elliott Management's campaign. Citrix Systems ( (CTXS) ) was also a target of pressure from Elliott Management and opted to merge its GoTo business with LogMeIn ( (LOGM) ).

Paul Singer's Elliott Management has carved out a niche by focusing on technology companies and built a strong track record pushing for M&A at large-cap tech firms. It has successfully pushed for sales of Qlik Technologies and Informatica, among others. The fund is currently agitating for change at Imperva ( (IMPV) ) and Mentor Graphics ( (MENT) ).

F5 Networks, too, could play a role in the industry consolidation, but it also isn't an asset that strategics are "begging" to own, Ferragu added, noting the question largely remains who would step up to the plate with what would be a sizable check.

"It's a fairly big company," he said, referring to F5 Networks'  $7.94 billion market capitalization. And the valuation could easily reach $10 billion with a decent premium.

But F5 Networks isn't also "your typical badly-run company" the way Infoblox and others had been, Needham & Co. LLC analyst Alex Henderson cautioned, adding that the Santa Clara, Calif.-based network infrastructure services provider was dealing with serious operating problems.

That's not to say F5 Networks doesn't have steps it could take to better position itself.

Henderson explained that F5 Networks could pivot its strategy from being a pure application delivery services (ADS) company to becoming a mini Cisco Systems ( (CSCO) ) that has its own distribution channel. It could do that with M&A, he added. While players like Cisco have pursued more needle-moving acquisitions that gave the company access to large swaths of end markets, F5 has largely pursued tuck-in acquisitions.

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F5 Networks' peers came under activist investors' fire partly due to weak valuations sparked by wary investors fearing that transition to the public cloud would phase out F5's IT infrastructure. The sector's valuation compression began in 2013, according to Henderson, who said valuations fell, and stayed down for the most part.

Elliott pressured Juniper Networks ( (JNPR) )  early in this cycle until it settled with the activist and appointed two dissident-backed directors to the board last year.

Security companies have been exposed to activism because they built their organizations for rapid growth and have subsequently left holes for opportunities to improve margins and streamline operations, Morningstar Inc. analyst Ilya Kundozerov wrote in an email. As computing workloads are moving to the cloud, it is difficult to find new areas for growth for some IT infrastructure stalwarts, he added.

"Some names are transforming from growth category to the cash cows. Here again, activist investors and private equity firms are the best candidates to institute strict expense control and drive up a share price," Kundozerov said.

PE firms have been active M&A participants in this sector. In case of F5 Networks, financial sponsors are also the likely candidates to take a swing.

The integration of F5 products into a strategic's product line-up would be difficult because F5's software and hardware are vendor-specific, Kundozerov explained, adding that such a task would require a lot of work.

If an activist launches a campaign at F5 Networks Inc. they won't be able to effect change quickly. Investors can't call special shareholder meetings or act by written consent to expedite any director-election efforts. As a result a proxy contest would need to take place at the technology company's upcoming annual meeting, expected in March. However, an activist could seek to take control of F5 Networks board because all directors are up for election annually.

Meanwhile, F5's investor base already has shareholders like Blue Harbour Group with a track record of activist campaigns.

Blue Harbour, which owns a 1.46% F5 stake is known for taking a collaborative approach to affecting change, spending several years behind the scenes with boards and management. The fund also only purchases stakes if it supports the management and it does not launch proxy contests.

For example, the Greenwich, Conn.-based firm was behind the sale of Rackspace Hosting ( (RAX) ).

Blue Harbour's Clifton Robbins started accumulating shares back in 2014 when it revealed through a filing that it planned to engage in talks with the company's management and the board as well as potential strategic partners or competitors. The cloud services provider ultimately agreed to be acquired by Apollo Global Management for $4.3 billion in August.

-- Ronald Orol contributed to this report.