Infrastructure
Commentary
11/12/2004
05:40 PM
William Schaff
William Schaff
Commentary
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Taking Stock: F5 Networks Thrives On Internet Traffic

F5's integrated products focus on architecture that manages net traffic.

There has to be a way to manage network traffic flow more efficiently. While Cisco Systems gets a lot of the headlines, niche players such as F5 Networks, a leader in application-traffic management, have survived and thrived in Cisco's shadow.

F5's integrated products and services focus on an architecture that has advanced application support, security, and access that's designed to manage and optimize Internet traffic. F5 has a broad product line that includes its BIG-IP version 9 application switch, which uses its new Traffic Management Operating System. The updated architecture of BIG-IP integrates many features, including traffic compression, traffic optimization, and security functionality such as firewalls. The system controls network traffic based on a combination of application and user criteria. This ensures that important applications are given priority and the necessary bandwidth to perform. The architecture also allows the selective encryption and decryption of stored information as required. No wonder it has won more than its share of new business. F5's FirePass controller provides flexible remote access to business applications. It allows access for authorized users using everything from handheld devices to dial-up as well as standard Web-based browsers. Meanwhile, F5 recently introduced TrafficShield, an application firewall.

Despite all the good product news, competition remains keen. The company's BIG-IP switches compete with products from some large companies such as Cisco and Nortel Networks, as well as aggressive smaller companies such as Inkra Networks and Radware. F5's FirePass SSL-VPN security gateway competes with many other products, including Juniper Network's NetScreen appliance. And the firewall market is quite diverse and competitive.

This hasn't seemed to hurt the company in recent quarters, as its fundamentals remain strong. The company just closed its fiscal fourth quarter 2004, ending Sept. 30. Revenue for fiscal 2004 was $171.2 million, up 48% year over year. Seventy-four percent of revenue comes from products; the balance is made up of service revenue. Because of this revenue mix, in my opinion, gross margin was an attractive 77% in the latest fiscal fourth quarter. The company's earnings per share on a fully diluted basis was reported at 43 cents but was actually closer to 28 cents on a fully taxed, normalized operating basis, slightly higher than Wall Street consensus. Deferred revenue grew 7% quarter over quarter.

Guidance for next quarter was higher than analysts' consensus, giving the company's investors an optimistic outlook. With no debt as of Sept. 30 and more than $140 million in cash and investments, in my opinion, investors can be confident that F5 is a viable concern. However, at a price of $42 per share and a forward fiscal 2005 price-to-earnings multiple of 45 based on First Call's 2005 consensus earnings estimate of 93 cents per share, I believe the stock is fully valued. However, considering the ups and downs in this market, there may be another time to buy this stock at a more attractive price.

William Schaff is chief investment officer at Bay Isle Financial LLC, which manages the InformationWeek 100 Stock Index. Reach him at william.schaff@bayislefinancial.com. This article is provided for information purposes only and shouldn't be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any security. Bay Isle has no affiliation with, nor does it receive compensation from, any of the companies mentioned above. Bay Isles current client portfolios may own publicly traded securities in one or more of these companies at any given time.

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