Riverbed Completes OPNET Merger to Little Fanfare

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Back at the end of October, in the midst of Hurricane Sandy, Riverbed Technology (NASDAQ: RVBD) made an accretive deal to purchase OPNET Technologies that caused the stock to plummet 18%. While investors clearly didn’t like the stock back then, the mood hasn’t improved significantly now with the stock trading between the original post announcement days range.

The deal provided the leader in the WAN optimization market inroads into the application performance management (APM) sector that ties in perfectly to and extends the network performance management (NPM) of Riverbed’s Cascade product.

So why were investors so negative on the deal? Was it the plan to borrow debt or the price paid for OPNET?

Debt financing

Investors probably think the company paid an excessive amount for a questionable product line. The major counter for long-term investors is the fact that the deal will be accretive immediately.

In what probably didn’t please most investors, the company borrowed $575M instead of the original expectations of $500M. The interest rate is as low as a 2% margin plus the prime rate of Morgan Stanely Senior Funding or 0.5% above the federal funds effective rate. See more details in the SEC filing.

In a rough estimate, Riverbed will pay roughly $15M in annual interest costs. Those numbers are vastly below the expected $30M of income generated from OPNET before any synergies from the merger.

Mizuho loves the deal

Another perplexing aspect to the stock reaction to the deal is the fact that Mizuho Securities’ Gabriel Lowy raised the price target on the stock back in early December from $27 to $32. Not only is it odd to see such a discrepancy in a price target from the current price, but also the analyst that already expected a 50% gain upped it to over 75%.

The analyst is bullish that Riverbed will be able to pull higher non-GAAP operating margins out of the OPNET business line. Combined with paying for most of the deal with cash via cheap debt, the analyst raised the 2013 estimates to $1.27.

According to Yahoo! Finance, analysts have been shy on raising earnings estimates for 2013. Though the company was clear that the deal would be accretive, the analyst estimates have remained flat at $1.19 for next year. Combined with a solid beat on Q3 earnings due to the updated product line growing faster than expected, investors should have expectations for this stock to rebound to the pre-merger range of $22 to $24.

Fragmented Sector

A major reason to love the deal is that the APM sector is very fragmented. Gartner lists Compuware (NASDAQ: CPWR), BMC Software (NASDAQ: BMC), and IBM (NYSE: IBM) as leading competitors. The below chart provided in the deal presentation shows OPNET as a leader in the group:

<img src="/media/images/user_15227/screen-shot-2012-12-29-at-13451-am_large.png" />


Riverbed expects to be able to meet customer needs better with a combined solution of NPM and APM features that competitors such as BMC and IBM can't match with a focus on the APM sector alone. The goal is to merge the sectors into a performance management concept that aims to detect and fix performance problems before business is impacted.

Amazon Web Services

The company added the Cloud Steelhead WAN optimization solution and the Whitewater cloud storage gateway product to the Stingray application delivery controller already available on Amazon Web Services (AWS). The Stingray product has been successful on AWS since 2009.

Barclays analyst Jeff Kvaal expects the deal to help the Whitewater product to gain traction in the market after currently only accounting for 1% of sales.

Any additional revenue from Amazon would be icing to the investment thesis in Riverbed and add further to the under recognized growth potential of the company.

Conclusion

In 2013, investors might do well to find stocks that are able to utilize cheap debt financing to purchase assets that provide earnings growth far beyond what the company could make with interest income.  

Riverbed has the great opportunity to consolidate a market adjacent to existing core competencies while utilizing cash flow to quickly pay for the purchase. While investors fretted over the use of funds and purchase price, savvy investors will enjoy the larger share of earnings that the new assets will generate compared to hoarding cash.


Mark Holder and Stone Fox Capital Advisors,LLC own shares in Riverbed Technology. The Motley Fool owns shares of Riverbed Technology. Motley Fool newsletter services recommend Riverbed Technology. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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