Analysts Largely Convinced Of F5 Networks' Deal Rationale, But See Execution Risk

F5 Networks, Inc. FFIV announced Monday a deal to acquire privately held NGINX, which provides an open-source software going by the same name, for $670 million in cash.

The Analysts

• Raymond James analyst Simon Leopold maintained a Market Perform rating on F5 Networks.
• JPMorgan analyst Samik Chatterjee downgraded the shares from Outperform to Neutral and reduced the price target from $210 to $183.
• Morgan Stanley analyst James Faucette maintained an Underweight rating and $130 price target.
• RBC Capital Markets analyst Matthew Hedberg maintained a Sector Perform rating and $166 price target.
• KeyBanc Capital Markets analyst Alex Kurtz maintained a Sector Weight rating.

Raymond James Sees Execution Risk

The NGINX acquisition improves F5 Networks' software mix, provides a contemporary architecture and will likely improve its position with public cloud players, Leopold said in a Monday note.

Yet the analyst cautioned of execution risks such as the potential for customer confusion and talent retention. The prospect of introducing a dividend — now that the company has suspended its stock buyback plan — should help the stock, the analyst said. 

JPMorgan: Acquisition Moderates Earnings Growth

The deal valuation for NGINX sets the bar quite high from the perspective of delivering of growth and revenue synergies, Chatterjee said in a Tuesday note. 

The acquisition is going to significantly moderate the company's FY21-22 earnings expectations of high-single to double-digit earnings growth to low-single-digit growth, dragged by both margin dilution from the integration of NGINX as well as suspension of buybacks, the analyst said. 

JPMorgan expects this to significantly impact investor interest ahead of visibility into execution on Horizon 2 targets.

See also: F5 Networks Customers Are Migrating To The Public Cloud, Analyst Says In Downgrade

Morgan Stanley Sees Estimates Increasingly At Risk

Even with the NGINX acquisition, estimates for F5 Networks are increasingly at risk as the hardware product cycle continues to mature, Faucette said in a Tuesday note. 

The analyst said he is below consensus for fiscal year 2019 and beyond, factoring in the negative trends from Morgan Stanley's surveys and longer-term concerns expressed by channel contacts.

Faucette said he expects the stock to trade down to his price target as meaningful revenue growth upside fails to materialize.

"We expect the company to continue repurchasing shares and limit opex growth to achieve $11 in long-term EPS, but the stock's multiple is likely to contract if better topline growth doesn't materialize." 

RBC Says Deal Makes Sense

The NGINX deal makes sense, with the linking of the DevOps with NetOps likely to serve customers with traditional and modern enterprise-grade services in any environment, Hedberg said in a Tuesday note. 

"The deal should accelerate near term software/overall revenue growth and dilute operating margins by 200 bps, but secure FY/21-22 growth objectives," the analyst said. 

Given investor expectations for M&A to focus on security, RBC said a future deal in security/software cannot be ruled out.

KeyBanc Encouraged By M&A Announcement

The deal is a strategic move to shore up the company's cloud-native strategy, as it brings it closer to app developers who are building cloud-native workloads, Kurtz said in a Monday note. 

The company's guidance suggests NGIMX will add $40 million to $60 million in fiscal year 2020 revenue and increase the growth outlook by several points, the analyst said. 

"We are encouraged by this announcement, as we believe the longer-term upside for F5 will be driven by the gradual shift of the company's economic buyer from the infrastructure/networking teams to application developers, which are often impacting revenue projects." 

The Price Action

F5 Networks shares were down 7.5 percent at $149.94 at the time of publication Tuesday. 

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