2023-11-01 03:58:11 ET
Summary
- FFIV reports lackluster results in Q4 and expects potential flat to declining growth in FY24 due to uncertainties and softness from clients.
- FFIV sees sustained growth in applications and APIs, but expresses concerns about customer spending and mixed signals from different sectors.
- FFIV's long-term vision focuses on convergence and automation of applications and APIs, with promising growth potential in their distributed cloud services.
Investment action
I recommended a hold rating for F5, Inc. ( FFIV ) when I wrote about it the last time, as I remain cautious about the near-term growth trajectory despite seeing signs of stabilization. Based on my current outlook and analysis of FFIV, I maintain my hold rating due to the lackluster results in the fourth quarter. Moreover, the guidance from management for FY24 indicates a potential flat to declining growth trajectory, stemming from ongoing uncerta0inties and softness from its clients.
Review
In the fourth quarter of 2023, FFIV reported financial results that were below my expectations. The quarter's revenue stood at $707 million, representing 1% year-over-year growth. This revenue composition was well-balanced: 54% from global services and 46% from product sales. This distribution underscores a diversified and consistent revenue stream, highlighting FFIV's capability to generate income from both its services and product offerings. Projecting into the first quarter of 2024, FFIV anticipates its revenue to be in the range of $675 million to $695 million, with expected gross margins hovering between 82% and 83%. On the profitability front, the company aims for a first quarter non-GAAP EPS between $2.97 and $3.09 per share.
Zooming out, FFIV foresees a sustained growth trajectory for applications and APIs, driven by automation efforts and the rise of novel use cases such as generative AI. Yet, the company voiced concerns over customer spending, expecting this cautious trend to persist into FY ‘24, albeit at a stable rate. An intriguing insight shared by FFIV pertains to the future of application infrastructure. They speculate that as the proliferation of applications and APIs continues, there will be a juncture where customers will feel the need to reinvest in their application infrastructure, potentially initiating this shift in FY ‘24. In summary, FFIV's fourth quarter performance was marked by encouraging signals from the enterprise domain, offset by a lukewarm reception from service providers. With a blend of optimism and prudence, FFIV is bracing itself for the challenges and opportunities the next fiscal year might present.
FFIV has a clear long-term vision that revolves around the convergence and automation of their customers' applications and APIs across various platforms, including data centers, cloud, and edge environments. The company is buoyed by the early signs of stability they observed in the latter half of 2023 and the resonance their converging portfolio has with customers. They boast an impressive install base of 20,000 customers, all of whom face significant multi-cloud challenges. FFIV stands out as the only company equipped to address these challenges comprehensively.
With the introduction of FFIV Distributed Cloud Services, the company has laid the foundation for future SaaS growth. This platform has garnered significant traction, especially with their security offering launched about 18 months prior to the call. This offering has seen rapid adoption, with 29% of its users being new to FFIV. In total, the company has acquired more than 500 customers for their SaaS services on Distributed Cloud, marking an increase of over 200% from the previous year.
The company's long-term operating model rests on three pillars, which they believe will enable them to achieve double-digit earnings at a compound annual growth rate. The first pillar is to deliver sustained mid-single-digit revenue growth. This growth is anticipated to be supported by FFIV's unique positioning in attractive end markets and their high-margin global services business. The company's strategy is deeply rooted in its belief in the continued growth of applications and APIs. They envision a future where they are the sole provider capable of delivering, securing, and optimizing any application or API, anywhere. Their solutions are tailored to fit each application and API, recognizing that modern applications require different solutions than legacy ones.
However, from the earnings call transcript of FFIV, certain concerns emerged. While there were positive signs from enterprise customers, the company remains unsure about the longevity of this trend, suggesting a mix of hope and caution. The current results were significantly influenced by the enterprise sector, notably in the technology and financial services domains. Conversely, a discernible softness was observed from service providers. The anticipated continuation of conservative customer spending into FY ‘24 further adds to these concerns. Additionally, FFIV's revenue forecast for FY ‘24, which could remain unchanged or even see a slight dip from FY ‘23, is influenced by a 6% setback from their FY ‘23 backlog reduction. Absent this challenge, the company's projection would have been a more optimistic low- to mid-single-digit revenue growth for FY ‘24. These points offer a window into the potential hurdles FFIV is gearing up to address in the forthcoming fiscal year.
Valuation
I anticipate that FFIV will experience a 2% decline in FY24, followed by a 4% growth in 2025. The assumptions for both years are based on the management's guidance and outlook shared during the earnings call. In this call, it was clear that encouraging signals from the enterprise sector had boosted FFIV's fourth quarter performance. However, a less enthusiastic response from service providers tempers this optimism. The earnings call transcript also revealed some areas of concern. While there were encouraging indications from enterprise clients, FFIV expressed reservations about the sustainability of this trend, suggesting a mix of hope and caution. A 6% decrease from their FY23 backlog also has an impact on the company's revenue projection for FY24, which could either remain constant or see a slight decline compared to FY23. On a brighter note, FFIV's long-term vision is characterized by their commitment to innovation, their belief in the growth potential of applications and APIs, and their ability to provide unique and tailored solutions to their vast customer base. They are strategically positioning themselves to capitalize on the challenges and opportunities presented by the evolving tech landscape.
“As a result of these factors, we expect our FY ‘24 revenue will be flat to down low-single-digits from FY ‘23, inclusive of the 6% headwind related to FY ‘23 backlog shipments. We also expect to return to mid-single-digit revenue growth in FY ‘25” source
FFIV is currently valued at a forward P/E of 11.97x, while its peers have a median forward P/E of 13.1x. Considering FFIV's EBITDA margin stands at 20.88%, which is below the peer median of 27%, and its net margin is 16.68% compared to the peer median of 19%, it seems justified for FFIV to have a lower forward P/E. My projected price for the stock is approximately $159, indicating a potential upside of about 6%. Given this unappealing risk-to-return profile, I maintain my hold rating on FFIV.
Risk and final thoughts
One potential upside risk to my hold rating for FFIV is the rapid adoption and growth of FFIV's distributed cloud services. The company has recently laid the foundation for future SaaS growth with this platform, and it has already garnered significant traction, especially with their security offering. If this momentum continues and FFIV successfully capitalizes on the increasing demand for cloud services and security solutions, it could lead to higher-than-expected revenue growth and profitability. This could, in turn, result in a positive revaluation of the stock, challenging the current hold stance.
FFIV's fourth quarter 2023 financial results were below my expectations due to its modest year-over-year revenue growth. While the company anticipates sustained growth in applications and APIs, there are concerns about customer spending continuing its cautious trend into FY ‘24. FFIV's long-term vision emphasizes the convergence and automation of applications and APIs, and their distributed cloud services show promise for future SaaS growth. However, uncertainties arise from the company's fourth quarter performance, with mixed signals from different sectors and concerns about the sustainability of positive trends from enterprise customers. Additionally, potential challenges in the upcoming fiscal year, as indicated in the earnings call, further cloud the outlook. Considering my target price and its weak outlook, the risk-to-return profile for FFIV is not compelling. Thus, I maintain my hold rating for FFIV.
For further details see:
F5, Inc.: Hurdles From 2023 Likely To Persist Through 2024