F5 Earnings: Project Delays, Budget Scrutiny Drive Software Decline; Fair Value Reduced to $170

We are lowering our fair value estimate for narrow-moat F5 FFIV to $170 per share from $199 after second-quarter results largely met our expectations but the outlook for the remainder of the fiscal year fell materially short. Macroeconomic factors continue to weigh heavily on F5′s product revenue, particularly its software revenue, which we believe to be the largest growth driver for the firm. As a result of a difficult macroenvironment, with heightened budget scrutiny, deferred projects, and customers sweating out existing assets, management lowered its revenue guidance for the full year.

In tandem with the updated revenue forecast, management is taking steps to operate the business with more financial discipline. As such, F5 is reducing its headcount by approximately 9% of its total workforce, increasing scrutiny on discretionary projects, reducing company travel and its facilities footprint, and reducing the size of its corporate bonus pool. While we do think increasing operational discipline during the current macroenvironment is wise, we are disappointed with the lack of software growth that is expected to persist throughout the fiscal year. Shares were down around 5% afterhours to $130 and we still view shares as undervalued, but would ask investors to see product revenue return to normal growth rates prior to investing.

Revenue growth in the quarter was 11% year over year, with services revenue again outperforming as customers continue to sweat out existing assets as budgets for new projects are increasingly scrutinized in the current environment. Systems revenue grew 43% year over year, more a result of F5 completing product redesigns and the ability to serve pent-up demand rather than an increased demand indicator. Management expects this quarter to be the peak for systems revenue this year. Software revenue fell 13% year over year and management no longer sees a path to the previously guided 15% to 20% in software growth for fiscal 2023.