F5 Networks (FFIV - Free Report) recently entered into a definitive agreement to acquire NGINX, an open source application delivery platform, for $670 million in cash.
The company believes the acquisition will close in the second quarter of 2019 to aid its software and multi-cloud transformation, thereby strengthening its growth trajectory.
By clubbing F5’s application security and application services portfolio plus NGINX’s software application delivery and API management solutions together, management expects the deal to “bridge the divide” between NetOps, which is F5’s strength, and DevOps, reflecting NGINX’s forte.
F5’s Application Delivery Controller (ADC) technologies are expected to gain traction from the addition of NGINX’s complementary capabilities. Further, NGINX’s strong developer community and its subscription-based business model are positives for F5.
Although the deal improves F5’s position within the DevOps ecosystem and helps boosting its long-term revenue growth, the near-term pressure on margins and earnings is a concern.
Further execution threats due to the challenges regarding technology, go-to-market and cultural integration are an overhang on the stock. Notably, the stock fell 7.67% to close at $149.65 on Mar 12.
Financial Implications of the Deal
F5 now expects "mid-single-digit" revenue growth in fiscal 2020 compared with its earlier forecast of "low-to-mid single-digit" growth. The company believes, the deal will increase its software and recurring revenue mix. Software revenue growth is now forecast at 35-40% from 30-35% in F5’s prior guidance.
Moreover, by fiscal 2021-2022, F5 expects the deal to help it achieve mid-to-high single-digit revenue and double-digit non-GAAP earnings per share (EPS) growth.
However, the acquisition is anticipated to dilute earnings and margins during the fiscal 2019 and 2020. F5 now anticipates "low single-digit growth" in adjusted EPS compared with its previous expectation of "mid-to-high single digit growth." F5 lowered its prior adjusted operating margins’ guidance of 35-37% to 33-35% over the same period.
Further, the company is likely to suspend its stock buyback program as it plans to pay for the deal with cash on its balance sheet. The company was intending to spend $100-$150 million on repurchases in the coming quarters.
F5 Networks exited the first-quarter fiscal 2019 with cash, cash equivalents and short-term investments of approximately $1.13 billion compared with $1.04 billion in the previous quarter. The company reported cash flow from operations of $197.9 million in the period.
Zacks Rank & Other Stocks to Consider
F5 currently has a Zacks Rank #2 (Buy). A few other top-ranked stocks in the broader technology sector are CommVault Systems, Inc. (CVLT - Free Report) , eGain Corporation (EGAN - Free Report) and Fortinet Inc. (FTNT - Free Report) , each sporting a Zacks Rank #1 (Strong Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.
Long-term earnings growth rate for CommVault, eGain and Fortinet is projected at 15.8%, 30% and 16.8%, respectively.
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