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Morningstar | Juniper Sees Turnaround in Cloud Vertical but Otherwise Conservative in Outlook; Maintain FVE

On Nov. 9, 2018, Juniper Networks hosted an Investor Day at which senior management delved into the company’s strategy, product roadmap, go-to-market, and financial outlook over the next three years. Aside from an expectation that weakness within the cloud vertical will abate in 2019, the company issued conservative growth and profitability guidance, with low-single-digit top-line growth and modest gross margin expansion through 2021. Management’s subdued optimism is starting to dovetail well with our bearish thesis on the firm’s long-term prospects, and we are maintaining our fair value estimate of $26 per share for the high-performance networking equipment provider. Our narrow moat and negative trend ratings also remain intact, as we continue to foresee secular headwinds that will erode Juniper’s competitive advantages over the long term.

No epochal revelations emerged from the event; however, we were pleased to come away with new details surrounding the firm’s customer base and product mix that lend credence to our financial outlook. For example, management divulged that 80% of service provider (SP) revenue comes from routing and in turn this contributes 60% to total routing revenue. Consistent with our views, this is a vertical that management thinks will continue to be challenging, with expected revenue contraction over the next three years as SPs struggle to revamp their own business models. Given the outsize contribution of the SP vertical to routing, we forecast that total routing revenue will decline at a roughly 2.25% CAGR through 2022.

Management also indicated that the top 10 customers within the cloud vertical accounted for 80% of total cloud revenue. We were not at all surprised by this figure, and this concentration undergirds our view that even as management sees the cloud weakness as largely behind it, growth will be lumpy and margin expansion difficult for primary products within this vertical.

One of these primary products, and the culprit behind much of the cloud weakness thus far in 2018, is the PTX family of routers. We were a bit surprised to learn that this product set, while much lower gross margin than the MX router family, still sat somewhere above the Juniper average of 60%, according to management. As this product becomes deployed more and more within the cloud vertical, we think its gross margin will continue to be driven down, given the concentration and procurement clout of the hyperscale cloud providers.

On the operating margin front, management views 2018 as an inflection points and its aim is to widen adjusted operating margins to 22% by 2021. Management thinks efficiency initiatives such as value engineering and supply chain optimization will facilitate this improvement, however, from our vantage point, we believe the firm will be hard-pressed to achieve this goal. In our view, margin accretive trends such as increased software sales should be offset by incremental investments in sales and marketing to maintain and win footprint, market pricing pressure, and the increasing commoditization of their hardware and software functionality.

In terms of strategy, management reiterated the framework within which it views opportunities in its three customer verticals. The firm sees the SP vertical as remaining weak but touted opportunities within the enterprise and cloud verticals. Multicloud remained a staple of the management team’s commentary, as the segmentation of IT infrastructure between multiple public cloud providers, private clouds, and on-premises deployments begets opportunities for vendors providing consolidated management, simplification, and automation across networking environments. We do not view the firm as competitively advantaged in this realm, however. As the value proposition moves further away from advanced hardware and ASIC performance and further toward the agility and orchestration capabilities of software platforms, Juniper will have to fight tooth and nail against better-positioned competitors. For example, VMware’s NSX platform is already used extensively for network virtualization and orchestration, and this firm has deeper partnerships with hyperscale cloud providers. Additionally, players such as Cisco and Arista are constantly adding capabilities to their centralized orchestration platforms, which will make it increasingly difficult for Juniper to differentiate itself competitively.