Synergies to Provide a Catalyst for Riverbed

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The market for network performance appliances has become so competitive that Riverbed Technology (NASDAQ: RVBD) now trades at a below-market earnings multiple of 12. With the purchase of OPNET last year, the network performance company for globally connected enterprises is facing a weak market for network equipment while it still works to achieve the synergies promised as part of the merger

The network equipment sector is facing a couple of trends that impact revenue, including weak government spending and a transition to software or virtual based solutions. Not to mention that both Cisco Systems (NASDAQ: CSCO) and F5 Networks (NASDAQ: FFIV) have become more formidable competitors recently. These combined issues have caused investors to sell Riverbed down to an attractive valuation.

OPNET synergies

With the maturing of the core WAN optimization market, Riverbed seized the opportunity to purchase a strong application performance management product company and expand it with the Riverbed distribution network. OPNET had limited international distribution and a weak enterprise sales profile. With the integration of the sales force during Q2, the combined company expects to achieve considerable synergies going forward.

The company wins with the only combined end-to-end solution in the network performance management and application performance management products. The increased distribution should help sell more OPNET products even without the synergy and combined solution benefits.

Also, importantly Riverbed saw a strong 19% year-over-year increase in the US enterprise market, suggesting that the weakness in Europe and Asia could lead to strength in the second half of the year. The fears of a maturing WAN optimization market might be overdone with the real damage done by lower government spending and weak international economies that impacted all technology sectors.

Increasing competition

If the market wasn’t tough enough with the sequester in the US and austerity cuts in Europe, Riverbed appears to be facing tougher competition in the core WAN optimization market. According to UBS, Riverbed’s market share fell from approximately 43% in the prior year to only 40% in Q1. Cisco Systems was able to maintain share at around 20% while F5 Networks grew to 7% of the market. Combined, the three firms control only 70% of the market, providing the ability to gain share in a market that still remains rather fragmented for a mature area.

While this data doesn’t back up the claims of Riverbed management that it controls 50% of the market and wins 90% of the deals where it competes against Cisco, it does highlight a major concern for investors. Both Cisco and F5 are considerably larger firms with strong balance sheets, but companies that focus primarily on other markets.

Cisco has a market cap of $129 billion and a revenue base of nearly $50 billion, suggesting the company will have a difficult time turning the focus towards a WAN Optimization market where its revenue can’t be much more than $100 million on a quarterly basis. The company has a net cash hoard of $30 billion, providing it with the resources to control the market if it so chooses. Even with this massive size, the stock trades at a similar forward multiple of around 11 times earnings, highlighting the value in Riverbed’s stock.

F5 Networks has a market cap of $6 billion and a revenue base of around $1.5 billion, but with a very mature application delivery controller market the company is looking for other segments to penetrate. With the company gaining market share in the WAN optimization market it might be a bigger threat than Cisco.

Bottom line

Stocks are always cheap for a reason so the question exists whether the growth of the domestic enterprise market was more indicative of the total market or not. Either way, it doesn’t appear Riverbed can get cheaper with the company able to repurchase $25 million in stock and repay $50 million of debt during Q1 alone.

As with any tech sector, the market will remain competitive but Riverbed appears to have the products to combine the network and application performance segments. With any success integrating OPNET in the second half, the stock offers a very cheap and compelling valuation with a major catalyst to propel the stock higher.

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Mark Holder and Stone Fox Capital Advisors, LLC own shares of Riverbed Technology. The Motley Fool recommends Cisco Systems, F5 Networks, and Riverbed Technology. The Motley Fool owns shares of F5 Networks and 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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