Description

Juniper Networks Inc. (NYSE:JNPR) designs and develops products (predominately routers and switches) and services utilized in high performance networks, such as cell phone and television service providers.  Over the past year, we believe JNPR has made drastic strides in regards to spending discipline, capital allocation, and management.  Through these initiatives, combined with improving end market dynamics, we believe meaningful upside exists to the Company’s current share price of $27 / share.

Elliott Management launched an activist campaign against JNPR in late 2013 that helped to expedite the improvement in the Company’s corporate governance.  Prior to this campaign, JNPR’s primary issues revolved around poor cost discipline and capital allocation.  The Company had one of the highest operating expense to sales ratios of all IT telecom equipment networking stocks.  Despite limited top-line growth, operating expenses as a percentage of sales grew by nearly 5% between 2008 and 2013.  No place was this more evident than in R&D spending, in which the Company spent 21% of its revenue annually versus 11% for peers.  Even though it still generated cash and had over 30% of its market capitalization in net cash, it was one of only four Hardware & Equipment companies (out of 35 globally) that did not pay a dividend.  It also did not meaningfully buy back its stock.  When the Company did allocate capital, it had a terrible track record and destroyed billions of dollars of value.  From its IPO through 2013, the Company spent over $15 billion on acquisitions and R&D, the end result of which was a series of failed acquisitions and very few new product launches that were well received.  Due to these missteps, the Company’s stock underperformed its peers 121% since its IPO and was down 45% from 2011-2013 versus the Nasdaq at +59%.

In 2014, the Company made a series of operational and strategic improvements that we do not believe have been appreciated by the market.  It started when the Board (pressured by Elliott) immediately replaced the CEO and altered management’s incentive compensation to focus on margin improvement.  The new management team then implemented an Integrated Operations Plan, in which it committed to lowering operating expenses by 10% by 2015.  Not only did JNPR become more stringent on how R&D dollars are spent, it also committed to focusing only on its most core assets.  This culminated in the second asset sale in the Company’s history (the first was in 2006), along with another previously acquired business being completely disbanded, a stark contrast to the Company’s acquisition strategy of the past. 

The most marked change, however, was in regards to capital allocation, where JNPR started returning a significant amount of its strong free cash flow and net cash to shareholders.  It instituted its first ever dividend in July 2014 and committed to a $4.1 billion share repurchase program between 2014 and 2016.  It surpassed its short term goal by repurchasing $2.3 billion of stock in 2014 alone (20% of the Company’s shares outstanding) and committing to acquire another $1 billion in stock in the first half of 2015 (another 10% of outstanding shares).

Despite implementing these various operational initiatives to improve the Company, generating an 8+% free cash flow yield, implementing a dividend, and repurchasing a significant amount of stock, Juniper stock was still flat throughout 2014.  This was primarily due to the Company missing earnings expectations several straight quarters in the back half of 2014 caused by weak carrier capex, including weak capital spending by Verizon and AT&T. 

However, we believe industry dynamics are turning, and JNPR has now positioned itself to highlight its operational and strategic improvement.  Firstly, we believe Verizon and AT&T’s quarterly capital expenditures bottomed in Q1 2015; JNPR has historically outperformed in the period following trough capex from the two large telecom providers.  We think telecom capex has bottomed due to several factors, including easy comps starting in Q2 (capex underperformed starting in Q2 of 2014), AT&T starting the process of virtualizing 75% of its customer-facing network by 2020, and Verizon and AT&T starting to upgrade its metro networks.  In fact, a recent Goldman Sachs survey suggests enterprise network equipment spending intentions have increased to the highest level since April 2008.

However, aside from the projected cyclical increase in spending from telecom providers, we believe the market has yet to appreciate how JNPR has structurally improved its business mix, since it has been masked by the cyclical weakness from telecom providers.  Since 2012, telecom as a whole has come down from 44% of total sales to 38% of sales, while cable and Web 2.0 (Facebook, Google, etc) have increased from 13% to 23%.  This not only diversifies JNPR’s end markets, but it also exposes JNPR to structurally higher growth end markets.  Another one of JNPR’s key end markets, federal, has been highlighted as a recent point of strength by Cisco, Aruba, Brocade, CDW, and NetApp.  Finally, JNPR has 32% exposure to EMEA (Europe, Middle East, and Asia).  We believe this will be a continued source of strength for JNPR, as Deutsche Telekom and Telecom Italia recently increased capital expenditures guidance, while CSCO highlighted strength in these geographies.

Juniper’s first half 2015 earnings have started to validate our thesis, as the Company reported strong results, with a book-to-bill above 1 and deferred revenue growing by 9%.  As these trends continue to improve from a cyclical trough, we believe JNPR stock will continue to re-rate into the mid-$30s.  Ultimately, we believe JNPR is a strategic asset to several companies in the industry, including Ericsson (in order for them to compete following the Nokia and Alcatel-Lucent deal).  In the event of a sale, we believe there is material upside from our fair value of mid-$30s.

Catalyst

Juniper’s first half 2015 earnings have started to validate our thesis, as the Company reported strong results, with a book-to-bill above 1 and deferred revenue growing by 9%.  As these trends continue to improve from a cyclical trough, we believe JNPR stock will continue to re-rate into the mid-$30s.  Ultimately, we believe JNPR is a strategic asset to several companies in the industry, including Ericsson (in order for them to compete following the Nokia and Alcatel-Lucent deal).  In the event of a sale, we believe there is material upside from our fair value of mid-$30s.