The task of this research paper is to conduct financial and investment analysis of the company under consideration. The biggest attention is going to be paid to analysis of the company’s stock performance. The reason for it is that we have to provide recommendations whether it is reasonable to invest in the company’s shares or not. Taking into account these goals, the paper is going to have the following structure: highlights of the company, business description, industry overview and competitive positioning, investment summary, valuation, financial analysis, investment risks.
The following company has been chosen for analysis – F5 networks. There are few reasons why we have chosen this company. First of all, it performs in high technology industry. We believe that this industry is really promising. As a result, stocks have a great potential for growth. It is not surprising that the company was listed in Fortune’s 100 fastest-growing companies list in 2010. Second of all, this company is well-known. Respectively, information about the company’s is readily available.
Highlights of the company
To begin with we would like to provide some background information about the company under consideration. Thus, F5 networks is an American company which specializes in networks appliances. The company produces and sells network appliances. The most famous company’s product is a BIG-IP appliance. F5networks is quite a young company. It was founded only in 1996. However, it has become one of the leaders on the market, since that time. It has more than 2000 employees and its annual revenue is more than $1 billion. Among the main company’s competitors the following ones may be pointed out: A10 Networks, Array Networks, Zeus Technology, Radware, etc. Some additional information about the company can be got from the following quote.
“F5 Networks, Inc. provides application delivery networking technology that secures and optimizes the delivery of network-based applications, and the security, performance, and availability of servers and other network resources. The company sells its products to enterprise customers and service providers through various channels, including distributors, value-added resellers, and systems integrators in the Americas, the Middle East, Africa, Japan, and the Asia Pacific. F5 Networks, Inc. was founded in 1996 and is headquartered in Seattle, Washington” (F5 networks company profile).
Thus, the company performs in highly technological industry. It is characterized with narrow specialization in production and sales of network appliances. Also, it provides all the presale and after sale services. The company has a broad assortment of such appliances. The most well-known is a BIG-IP appliance. Taking it into account, we can say that development and success of the company depend on development of Internet and communication industries. The company uses the whole range of sales channels to distribute its products – from traditional stores to online platforms. Despite the fact that the company is quite young, it demonstrates high pace of development. Also, the company has already got a positive reputation on the market. As a result, it has some constant and loyal customers, who can be a reliable basis for further development of business.
The main features of this kind of business are the following: the business is really technological – that is why it requires constant innovation approach in order to handle competitive fight; the business requires significant production facilities; success of the business depends on success of related and supportive industries; business is characterized with high degree of competition, etc.
Another important characteristic of the business is that the company tries to use the different sales channels. It is very important that the company develops online segment of the business, taking into account the role of Internet in the modern society. We believe that such strategy is going to increase the company’s sales significantly.
Industry overview and competitive positioning
It has been already mentioned that this industry is very promising. We can even call it as a segment of IT-industry. The last one has demonstrated the most tremendous pace of growth in the nearest past. Such companies as Google and Facebook are among the most capitalized companies on the world’s market. It is not a secret that performance of these companies and their services are based on networks and communication. It is impossible to imagine development of Internet without effective network and communication systems. That is why we may assume that demand on F5’s services is going only to grow. Thus, perspectives of the industry are quite positive. One more evidence is that this industry has managed to survive the global financial crisis quite successfully.
The global financial crisis and its consequences are other important factors that should be taken into account in the process of making investment decisions. We believe that the crisis has not ended yet. As a result, the stock markets do not show their highest pace and capacity. In turn, it means that they have not reached highest pace of growth. It is the best time to enter the market, if you want to get highest profits. We may expect significant growth after the crisis ends. It will be too late to enter the stock market. Our opinion about positive perspectives of the industry under consideration can be proved by the following words.
“The explosion of data volumes and types — real-time data, social networks, video, telepresence, virtualization, cloud, VoIP, intelligent electronic devices (e.g., RFID), and UC&C — is all raising the raw network throughput and manageability bar for both SPs and enterprises. Service assurance for the user experience, the consumerization of IT, analytics, network topology expansion, and private and public cloud are key market drivers over the forecast period. The relentless expansion and complexity of networks will require simplified network deployment and management tools to ensure satisfactory business delivery” (Doyle).
The last thing we would like to say talking about the company’s positions in the industry is about competition. The degree of competition is quite severe in the industry. Moreover, we believe that is only going to grow in the nearest future, since new companies will be entering the market. We have already mentioned about F5’s main competitors. The current competitive positions of the company under consideration are quite satisfying. However, growing degree of competition is going to require innovation approach to business from the company and ability to exceed expectations of customers.
Thus, we have analyzed the current industry’s positions and its perspectives. Now it is time to analyze the company’s financial performance. We are going to do it via the instruments of financial analysis. Two types of financial analysis will be used – horizontal financial analysis and ratio analysis. Horizontal analysis is going to show us the trends in development of the company. The following areas of the company’s performance will be analyzed: profitability, liquidity, financial stability and debt management.
The company have been demonstrated a positive tendency to growth and development in the last four years. The main indicators such as revenue and total assets have been growing. For example, revenue has doubled for the last four years. It is a very positive sign, which proves our opinion that the company is still developing and growing. The same situation is with the other financial indicators. Generally, we can say that the company is constantly developing. It is a double-side process. On the one hand, growing total assets allow company to get higher sales and, respectively, revenues. On the other hand, additional revenue is invested in the company’s assets. For example, the company invests a lot in modernization of production facilities. As it has been already mentioned the industry is highly technological. That is why it is very important to use the best production facilities and propose the most innovative products. We believe that such strategy is beneficial in a long-term perspective.
In order to get clearer picture we must use the so-called ratio analysis of the company’s performance. As it has been already mentioned, four main sides of the company’s performance are going to be studied – profitability, liquidity, financial stability and debt management. The following ratios have been used – ROE, ROA, current ratio, ratio of financial independence, debt management ratio.
First of all, we must say that the company under consideration is characterized with high degree of liquidity and profitability. It is a good sign for the company’s creditors and investors. It means that the company is able to generate positive cash flow, required to pay off its debts. Also, the company is characterized with high degree of financial independence. It is a sign of financial stability of the company, since it finances its development via equity financing. It means that the company does not depend on conjuncture on financial markets. Moreover, the degree of financial independence is very stable. It also proves the fact that the company has effective strategy of financial management.
Generally, we can say that financial conditions of the company are quite satisfying. It should have been reflected in performance of the company’s shares. The company’s shares have demonstrated positive dynamics in the last four years. The current price levels are quite stable. It means that it is time to enter the market. The reason for it is that the prices are going to grow in the nearest future. Respectively, it is possible to earn significant profit. However, investment decision depends on a lot of other factors. Among them the following ones may be pointed out: perspectives of industry, perspectives of a company; fair price of a company’s shares and the difference between it and the current prices; overall economic situation; transactional costs of making a deal; financial abilities of an investor, etc.
One of the most important tasks is to define the so-called fair price of a company’s shares. Fair price of a company’s share is a price that accounts a company’s financial abilities and potential positive cash flows in the future. There are a few ways to calculate a fair price. We are going to use two of them – DCF and comparative valuation. That is why it is very important to explain the essence of these two instruments of valuation. In our opinion, one of the most appropriate definitions of the term comparative (peer) valuation is the following.
“Comparative valuation is a process used to evaluate the value of a company using the metrics of other businesses of similar size in the same industry. Comparable company analysis (CCA) operates under the assumption that similar companies will have similar valuations multiples, such as EV/EBITDA. Analysts will compile a list of available statistics for the companies being reviewed, and will calculate the valuation multiples in order to compare them. Comparisons often involve creating benchmarks” (Comparative valuation definition).
Simply speaking, comparative valuation is based on the principle that similar company with similar financial results should demonstrate the similar shares’ prices. That is why price of a share of a particular company is compared to the average price in the industry. Then we can determine whether a company’s shares are underestimated or overestimated. This method is really easy to use. Even a typical investor may calculate a fair price, using this instrument. However, DCF method is more precise. On the other hand, it is more complicated, and is usually used by specialized investment companies.
“DCF is a valuation method used to estimate the attractiveness of an investment opportunity. Discounted cash flow (DCF) analysis uses future free cash flow projections and discounts them (most often using the weighted average cost of capital) to arrive at a present value, which is used to evaluate the potential for investment. If the value arrived at through DCF analysis is higher than the current cost of the investment, the opportunity may be a good one” (DCF definition).
This instrument is based on the principle that a share’s price reflects future cash flows from a company’s performance. Discounted value of these cash flows is calculated. Weighted average cost of capital is taken as the rate for discounting. Then the value is divided into the number of outstanding shares. As it has been already mentioned, this method is quite complicated. That is why it is mainly used by specialized investment and other financial companies. Therefore, these two methods are going to be used in the report to calculate fair price of a share of the company under consideration.
In order to make the final decision we must realize the fair price of the company’s shares. We have used comparative valuation and DCF analysis to determine this fair price. The final conclusion has been made, basing on both approaches. 40% of the price was related to comparative valuation and 60% of the price was related to DCF. Using comparative valuation, we had to choose appropriate peers. These peers were the mentioned main competitors of the company. Also, it was very important to choose right multipliers. We have chosen the following multipliers: EV/EBITDA, P/E and P/BV. Their shares in the final price were 35%, 35% and 30%.
In order to use DCF we forecasted the company’s future cash flows, basing on the average levels for the last five years. As the discount rate we have used WACC. We have discounted calculated cash flows and then divided value into the number of outstanding shares.
After all the calculations, we may say that the fair price of the company’s shares is $112. It means that the shares are traded below the level of fair price. We believe that the main reason for it is the global financial crisis and its consequences. One of the main consequences of this crisis was damage for the global stock market. Thus, such low level of prices is not caused by the company’s performance. It is the best time to but the company’s shares, because it is possible to get the highest capital gain.
Investing in some particular stock, a person expects to get revenue in the future. This revenue is the difference between a purchase and a sale price. However, expectations do not usually become real. The reason for it is influence of the whole range of investment risks. Among them the following ones may be pointed out: economic uncertainty and volatility, changes in the strategy and management, governmental interference, growing degree of competition, etc. It is the so-called general investment risks. They can be applied to any company from any industry. The company under consideration is associated with some specific risks.
First of all, there have been some changes and uncertainty in the company’s management in the recent years. Changes of management cannot be considered as a positive fact, since they usually are associated with changes in the company’s strategy. There is no guarantee that this strategy will be effective.
Second of all, technological industries are associated with patent procedures. Practice shows that these procedures may lead to conflicts. For example, we can mention conflict between Samsung and Apple, which has happened recently. Currently the company can be called safe in this context. However, there is no any guarantee that such situation will not happen in the future.
Third of all, we can say that the company is characterized with a low degree of business diversification. Its assortment is limited, the company performs on a few local markets, it has a few main vendors, etc. As a result, the company depends on a few business agents and segments. Problems in some one segment may create significant overall problems for the company.
All the mentioned risks are able to influence the company and spoil its financial results. As a result, price of the company’s shares will fail. However, we may say that possibility of the mentioned risk factors is not significant, at least, at the moment of valuation.
Conclusions and recommendations
To conclude we would like to say the following. The company under consideration performs in technological industry. It is quite new company, but it has managed to reach significant financial results and got positive reputation on the market. It already has its constant and loyal customers. The company is characterized with a high pace of development and growing sales. Generally, financial performance of the company can be called as satisfying. It is characterized with a high degree of profitability and liquidity. It is a good sign for the company’s creditors and investors, since it means that the company is able to generate positive cash flow to pay off its debts. Also, the company is characterized with high degree of financial independence. It is a sign of financial stability of the company, since it finances its development via equity financing. It means that the company does not depend on conjuncture on financial markets. Moreover, the degree of financial independence is very stable. It also proves the fact that the company has effective strategy of financial management.
Such positive financial results have resulted in good performance of the company’s shares. They have demonstrated stable growth for the last four years. However, the current price level is still lower than the so-called fair price, calculated by us, using comparative valuation and DCF. That is why we would recommend investing in the company’s shares. The moment for investments is also ideal. We have also provided investment risks for the company. They are the following: possible changes in management and strategy of the business; problems with patents; low degree of business diversification.
We are sure that their probability is low. That is why this company and its shares are good option for investments. Moreover, this option may be appropriate for both types of investors – aggressive and conservative.