2023-07-05 08:09:59 ET
Summary
- F5, a provider of application delivery, security and analytics services, faces headwinds as demand normalizes post-COVID and the importance of hardware declines.
- F5 has acquired a number of companies in recent years to support its software and cloud businesses but still needs to successfully integrate these companies into a cohesive platform.
- Despite strong hardware sales, F5's overall business is struggling, with weak software demand, declining margins and an uncertain ability to transition to a primarily software vendor.
F5, Inc. ( FFIV ) provides a range of services related to application delivery, security and analytics. The company was a large COVID beneficiary through increased hardware demand but is likely to face significant near-term headwinds as demand normalizes. F5's future is dependent on its software business, which is growing modestly, and the company is yet to demonstrate it can succeed as the importance of hardware declines and a range of endpoint solutions consolidate into platforms. Growth is weak and margins are deteriorating, and unless F5's acquisitions turn the company's fortunes around, the stock may continue to languish.
Market
F5 currently offers a range of application delivery and security products but started in Application Delivery Controller ((ADC)) hardware. An ADC is a networking device that directs web request traffic to optimal data sources in order to reduce unnecessary load from web servers. Functionality can also include application acceleration, compression, caching, traffic shaping, application layer security and SSL offload. Market leaders include F5, Radware ( RDWR ), and Citrix.
ADC functionality has developed incrementally over time, from an initial focus on scalability and availability towards security. Server load balancing is a reverse-proxy technology that provides scalability and the ability to add and remove servers without disrupting application availability. Server load balancers are also able to deliver availability by monitoring the status of applications through the use of active health check queries. Over time load balancers added content-based traffic steering capabilities, which meant it was a small step to also act as an application firewall. Load balancers have since continued to add application specific functionality (caching, compression, SSL offload, network address translation, and web application firewall).
NGFWs and WAFs both inspect traffic to try and stop malicious intrusions, but they offer a different layer of protection. They perform different tasks and are situated at different places in the network. Typically, an NGFW is a centrally managed system that can combine some network and web application firewall functionality, as well as VPN connections and other functions. Whereas firewalls decide whether to allow traffic and to what degree, ADCs determine what services to apply to traffic and where to steer traffic. Combining the two provides broader coverage. A network firewall can help stop an attack at the edge of the network by blocking incoming malicious traffic, which can benefit an application to an extent. The WAF will stop specific layer 7 attacks against the application.
Figure 1: Application Delivery and Security (source: F5 Inc)
The rise of cloud computing is now shifting the market toward multi-cloud application security and delivery. Applications are deployed across an increasingly diverse range of environments, which is making application delivery and security more important. Inconsistent technologies across environments creates technical and operational debt. In addition, rich telemetry can end up trapped in silos, limiting insights into app performance and the end-user's digital experience.
Application delivery and security for modern and traditional apps are also different, but both still need to be supported. 97% of organizations manage traditional apps while only 76% of organizations manage a mix of traditional and modern apps. While this shift presents F5 with an opportunity, it has also changed the basis of competition.
Figure 2: Traditional versus Modern Applications (source: F5 Inc) Figure 3: Impact of Modern Applications (source: F5 Inc) Figure 4: Growth in Traditional and Modern Applications (source: F5 Inc)
While there is still a large number of traditional apps, delivery for these apps is transitioning from on-prem systems to software and the cloud. This is potentially creating headwinds for F5's hardware business but is also an opportunity for the software business.
Figure 5: Transition of Traditional Apps to Software and Cloud (source: F5 Inc)
The ADC market is reasonably large, but also fairly mature, offering limited growth outside of SaaS.
Figure 6: Worldwide ADC Market - million USD (source: F5 Inc)
F5 believes that modern app delivery significantly increases its addressable market, and the company has made a number of acquisitions to pursue the expanded opportunity.
Table 1: F5 Modern Application Delivery TAM - million USD (source: Created by author using data from F5 Inc)
Application security will also potentially be a large growth opportunity over the next decade. Within this market, F5's portfolio addresses approximately two thirds of the TAM and this is expected to expand over time.
Figure 7: Application Security Addressable Market (source: F5 Inc)
While usage of AI in IT infrastructure and operations is currently low, it is expected to be another growth area going forward. F5 believes that an analytics platform built on top of its application services could have a 15 billion USD TAM by 2025. This type of analytics platform could address use cases like:
- AI enabled security and fraud protection
- Digital experience management
- App performance management and AIOps
- Analytics enabled business services
Figure 8: Planned AI Usage by IT Infrastructure and Operations (source: F5 Inc)
Together these markets (traditional app delivery, modern app delivery, security, analytics) provide F5 with a large TAM. It is unknown how competitive F5 will be in some of these newer areas though, particularly against cloud-native companies.
Figure 9: F5's TAM (source: F5 Inc)
F5 is currently facing headwinds from an uncertain macro environment, offset to some extent by easing supply chain bottlenecks. The overall IT spending environment has deteriorated meaningfully over the last six months, with increased budget scrutiny and deal delays across geographies. F5 has observed weaker software demand across verticals, particularly within technology and financial services. Larger deals have also been adversely impacted, like larger transformational-type projects. This is believed to be the result of economic uncertainty rather than competitive pressures though.
Improved supply chain conditions are allowing F5 to ship systems and reduce its hardware backlog. While this is currently a source of growth, F5 expects to exhaust its backlog later in the year.
F5
F5 is a provider of application security, delivery and analytics solutions, and believes it is pioneering the field of adaptive applications. While the company is a leader in application security, it has traditionally been more hardware focused and is attempting to expand its cloud and software presence through acquisitions.
F5 is trying to support the delivery of traditional apps in multi-cloud environments and enable modern app delivery at scale. F5 believes it is the only true multi-cloud player serving both traditional and modern apps and security with analytics. While the prevalence of modern apps is growing rapidly, traditional apps remain the dominant application architecture for most organizations. This will likely support F5's business in the near term, but there is considerable uncertainty regarding the company's competitiveness long-term.
Acquisitions
F5 has made a number of acquisitions in recent years to support its business transformation, including NGINX, Shape, Lilac Cloud and Volterra. The NGINX and Shape acquisitions are now reportedly largely complete . As a result, F5 is increasingly offering customers a single pane of glass for visibility and management of both NGINX and BIG-IP deployments. The Volterra integration is still ongoing but F5 has deployed all of its security capabilities onto the platform. Ultimately, F5 wants to offer customers a single console from which they can manage all of their security policies and gain visibility of their deployments.
NGINX
NGINX is a web server that can also be used as a reverse proxy, load balancer, mail proxy and HTTP cache. It is free and open-source software that is used by a large portion of web servers as a load balancer. As of June 2022, W3Tech's web server count of all web sites ranked NGINX first with 33.6%. Apache was second at 31.4% and Cloudflare Server third at 21.6%.
SHAPE
F5 acquired Shape Security in January 2020 to strengthen its security portfolio. Shape Security's software provides protection from automated attacks, botnets, and targeted fraud.
Lilac Cloud
F5 is acquiring the computer networking startup Lilac Cloud, which will now be offered as F5 Distributed Cloud CDN. F5 Distributed Cloud CDN provides security, content caching and support for containerized edge-based workloads. Lilac is expected to help improve on F5's edge service offering. Lilac also supports F5's solutions in areas like web application firewalls, API security, DDoS protection and bot protection.
Volterra
F5 acquired Volterra in 2021 to strengthen its edge service offerings. Volterra offers an edge-as-a-service platform that F5 is using to create a security focused scalable edge platform. Volterra's platform is small, but F5's management have stated that they have seen good traction with their Distributed Cloud Services.
Products and Services
F5 offers a broad range of products and services around application delivery, security and analytics. These are categorized under:
- Distributed Cloud Services
- NGINX
- BIG-IP
- Systems
BIG-IP
BIG-IP provides functionality like networking & application availability, performance, security, and access control, both in the cloud and on-prem.
NGINX
Modern applications provide business agility and improve the customer experience. They also increase complexity and reduce visibility. Modern apps change frequently, are built on containers, are designed for automation.
NGINX provides F5 with a range of capabilities that support its modern apps business. For example, NGINX Controller simplifies the complex modern app toolchain. App services managed by NGINX Controller simplify DevOps and IT Ops management and governance.
Figure 10: NGINX Controller (source: F5 Inc)
Aspen Service Mesh
Aspen Service Mesh provides an Istio-based microservices solution for service providers and medium- to large-scale enterprises. Istio enables organizations to secure, connect, and monitor microservices, so they can modernize their enterprise apps more swiftly and securely.
Shape
Application security is one of F5's strengths and is expected to be a growth area over the next decade. In the past F5's solutions were primarily on-prem, but the Shape acquisition adds cloud capabilities. The enhanced portfolio allows F5 to expand security sales within its install base.
Figure 11: F5 Application Security (source: F5 Inc)
F5 also plans to leverage the data collected by its application services by building a data platform on top of Shape. This will help to unlock the value of app insights, through data and AI. F5 has access to data from 67% of the top 10,000 websites, giving the company a broad view of application and user behavior across the internet.
Figure 12: F5 Data Insights (source: F5)
F5's analytics business is nascent, with the company still developing monetizable products based on the insights its data provides.
Figure 13: F5 AI and Automation Initiatives (source: F5)
Financial Analysis
Systems growth was strong in the first quarter on the back of supply chain improvements and system redesign efforts, which have helped F5 avoid supply chain bottlenecks. Systems revenue increased by 43% YoY but is expected to be lower through the remainder of the year. F5 still has a significant hardware backlog that it is working its way through, although this is expected to largely be gone by the end of the financial year, creating a 6-8% revenue growth headwind in FY2024. Software revenue declined 13% YoY in the second quarter of FY2023, illustrating the headwinds caused by the weak demand environment.
F5 is currently expecting low-to-mid single-digit revenue growth for FY2023, which is down slightly from the 9-11% growth previously forecasted.
Figure 14: F5 Revenue (source: Created by author using data from F5)
F5's ability to succeed primarily as a software vendor supporting the deployment of modern applications is uncertain. While hardware sales are currently strong, the rest of F5's business is struggling, and this is reflected in the number of job openings mentioning F5 in the job requirements.
Figure 15: Job Openings Mentioning F5 in the Job Requirements (source: Revealera.com)
Gross profit margins have been under pressure over the past few years, although this has been the result of supply chain issues and largely out of F5's hands. Gross margins are expected to improve in the second half of the year as supply chain pressures ease and F5's redesign efforts bear fruit.
Figure 16: F5 Gross Profit Margins (source: Created by author using data from F5)
F5 had strong operating profit margins in the past, but this has been undermined by its growing subscription business and gross profit margin headwinds. Margins appear to have stabilized recently though and should begin to improve as the business model transition matures. This will be supported by F5's growing base of software renewals , which are performing largely as expected.
Figure 17: F5 Operating Profit Margins (source: Created by author using data from F5)
Margins should also be supported by an increased focus on costs. F5 plans on reducing headcount by approximately 9% , in addition to:
- Rationalizing technology consumption
- Reducing its facilities footprint
- Applying additional scrutiny to discretionary projects
- Reducing the size of the corporate bonus pool
- Reducing travel
Headcount reductions are expected to result in annual savings of approximately 130 million USD, although the company will incur roughly 45 million USD in severance and benefits costs and other charges related to these actions.
Figure 18: F5 Cost Control Initiatives (source: F5)
Valuation
An argument could be made that F5 is undervalued, particularly if the shift to supporting the deployment of modern applications is successful. There is significant risk that this proves to be a value trap though. F5's core business has been rendered less relevant by technology changes, and the company is trying to negate this through acquisitions. There is considerable uncertainty as to whether these acquisitions can be integrated to create a competitive platform.
It should also be noted that revenue and growth are currently inflated by F5 working its way through a backlog of hardware orders. This will become a headwind in 2024 that could weigh on FFIV stock.
Figure 19: F5 Inc Relative Valuation (source: Created by author using data from Seeking Alpha)
For further details see:
F5, Inc.: Melting Ice Cube