Shares of F5 Networks (FFIV) have fallen nearly 6% since the company in the middle of December announced it was making a $1 billion acquisition to increase its presence in application security. Investors favor the growth and product portfolio diversification aspects of the deal, but aren’t too keen on the valuation or near-term earnings dilution.
Faced with increasing competition from virtualized appliances in its core application delivery controller (ADC) market and experiencing little top-line growth, F5 Networks has turned to the security space for expansion.
F5 is purchasing privately held Shape Security, a leading provider of application security for anti-fraud and abuse protection. The deal, expected to close by the end of March, more than doubles F5’s total addressable market in application security to $8 billion.
There’s plenty of growth potential in anti-fraud protection. The vast majority of all cyberattacks these days are aimed at applications or identities associated with applications, according to F5 Networks. Attackers now have the tools and automation capabilities to commit fraud at scale.
Cybercriminals are increasingly weaponizing by using botnets and targeted application attacks. In 2018, more than 3 billion credentials were stolen. With a constant flow of newly purloined credentials, attackers are able to open fake accounts to make fraudulent purchases and unauthorized funds transfers.
Founded in 2011, Shape Security protects against automated attacks, botnets and targeted fraud. The company on a daily basis detects and mitigates more than 1 billion automated attacks, while simultaneously protecting 150 million legitimate human log-ins. Shape Security is deployed on more than 200 million mobile devices worldwide. The company’s customer base includes eight of the top 12 U.S. banks, half of the top 10 credit card issuers and half of the top 10 global airlines.
Shape Security’s platform evaluates data flow from the user into the application, using AI and machine learning, supported by cloud-based analytics, to separate good traffic from bad. The company’s platform stands out because it protects against attacks that bypass other security and fraud controls.
There are some solid synergies associated with this deal. F5 provides an optimal insertion point for Shape Security’s service because of its location within the data flow of traffic in more than 80% of Fortune 500 application infrastructures.
Shape Security competes with CDN vendors and anti-bot specialists, but claims it has better blocking efficacy. Its competitors are not inserted into the traffic flow of enough applications.
Shape Security’s top-line growth rate of 50% is impressive. But F5 is paying more than 16 times trailing 12-month revenue of $60 million. While the acquisition is expected to be accretive to free cash flow within 12 months of closing, it’s going to take 24 months for it to be breakeven on an EPS basis.
With the acquisition, F5’s software contribution to product revenue for FY’20 (ending September) will expand to 35% from 25% to 30% previously. The deal is expected to accelerate F5’s FY’20 total revenue growth to the mid-to-high single digits from the mid-single digits. For FY’20, F5 is calling for total gross margin of around 85%, with operating margin in the 30% to 32% range.
F5 is funding the deal with cash on the balance sheet and $400 million in new debt. If the deal closes as planned by the end of March, Goldman Sachs estimates F5 would have $600 million in net cash remaining on the balance sheet, arguing the acquisition limits the potential for future share buybacks or other forms of cash distribution to shareholders.
Goldman keeps its “Sell” rating and price target of $117, as it remains cautious on F5 because it expects competition to heat up in virtualized ADCs now that VMware (VMW) has acquired Avi Networks. Prior to the deal announcement last month, BofA/Merrill had downgraded F5 to “Underperform’ and lowered its price target to $140 from $185, citing pricing pressure from negative secular trends and increased competition in the ADC market.
Calling Shape Security a best-in-class provider of application security solutions, Credit Suisse maintains its “Outperform” rating on F5, but cut its price target to $163 from $192 to reflect estimated dilution to FY’20 EPS.
Piper Sandler is bullish on the deal, keeping its price target at $168, saying the acquisition helps F5’s software and security transition, while also addressing a competitive hole in the company’s product portfolio. The firm is positive on the strategic vision and free cash flow accretion.
In 2019, shares of F5 fell 13.8%. Recently trading at $135.15, the stock is off 32% from its all-time high of $199.71 reached in September 2018.