October 20, 2009 - 12:00am EST by
2009 2010
Price: 24.00 EPS $0.00 $0.14
Shares Out. (in M): 75 P/E n/a 172.0x
Market Cap (in $M): 1,792 P/FCF 480.0x n/a
Net Debt (in $M): -269 EBIT 64 85
TEV ($): 1,523 TEV/EBIT 23.0x 18.0x
Borrow Cost: NA

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Riverbed (RVBD) was a hot tech IPO in Sept '06 and highflier that traded up to 10x consensus revenues in '07.  After falling sharply from Oct '07 through March '09, the stock is now up on renewed optimism: it trades at 4.7x '09 consensus sales and 172x consensus '10 earnings (consensus earnings for '09 are zero).  The company sells a networking box that does WAN Optimization - basically it helps branch office workers get better PC performance when they connect to applications running on servers in the home office.   This is a fast growing market, but not a "must have" for companies that are still struggling to emerge from tough economic times.  What's more, competitors-notably Cisco, Juniper, and Blue Coat-have used the downturn to improve their competitive offerings.  And in the long term, WAN optimization is better seen as a feature in branch office routers than a standalone product.  Analysts are expecting RVBD to earn 440 million and $0.14/sh in 2010, but I believe this view of a recovery is too optimistic and the valuation multiples too high.  If RVBD earns $0.14/share in '10 and trades at an elevated 35x multiple, then the stock would tumble 65% from its current level.




RVBD's main product is the Steelhead Appliance, which comes in a variety of price/power configurations tailored to different sized customers.  The solution requires an appliance to be placed at the client's main datacenter.  That box uses caching, TCP/IP optimization, and application optimization to reduce the data traffic sent to branch offices or mobile workers.  The branch offices need to have an appliance on their end to make the solution work, and mobile users need to have a software solution installed.  The result is that branch office workers experience faster performance when working on network-based applications on their PCs.  This performance improvement has been essential to Riverbed's marketing: their slogan is "Think Fast," and they argue that installing a Steelhead solution is cheaper than upgrading the network bandwidth to the branch office.


See a product list and network diagram here: http://www.riverbed.com/docs/SpecSheet-Riverbed-FamilyProduct_xx50_SMC-VE.pdf


Another benefit of this kind of network configuration is that network administrators can monitor the kind of traffic that is going over the network.  This can be useful for network performance analysis, reporting, security, and content filtering-for example, making sure branch office workers and not surfing sites they shouldn't be.  RVBD doesn't focus on security and filtering, but their competitors do.  Blue Coat (which acquired Packeteer last year) notably has been growing fast by offering security and content filtering bundled with WAN Optimization.  Given that the purchasers of these solutions are network administrators and CTOs, you can see why the security and filtering pitch would be successful.  In many companies, the IT organization is more motivated to focus on network security and reliability than on improving user experience.  RVBD recently acquired Mazu Networks, which has software for network performance analysis and reporting-showing the growing importance for these kinds of services to be bundled with the sale of WAN optimization appliances.


RVBD's advantage is principally that they were the first to market with a box that featured easy installation and good performance.  However, the solutions offered by competitors are catching up.  RVBD's patent portfolio consists of only 9 US patents, and according to industry experts these are insufficient to adequately defend the company's technology from fast followers.  Caching and TCP/IP optimization are not unique techniques to RVBD.  Application optimization can be done by anyone-it is a matter of configuring the solution to applications that are most frequently used (e.g., Outlook Exchange, etc.).  Given the lack of barriers to entry, it's not surprising that RVBD continues to invest heavily in R&D-around 18% of revenues-in order to keep improving and trying to differentiate the product.  As deployments become increasingly complex, WAN optimization performance improves, more and more applications become optimized, and customers require more and more sophisticated network analysis tools, I would expect R&D expense to continue to be a significant drag on profitability.


Another major competitor is Cisco.  They got into the market by acquiring a startup in 2005 and then created a division specifically to focus on WAN Optimization in Oct '06: a month after Riverbed's IPO!  Cisco's WAAS product can benefit from Cisco's huge installed base and salesforce.  Indeed, WAAS runs not only on a standalone appliance but also as a network module for the widely deployed Cisco Integrated Services Routers.  Cisco matches RVBD on features and is focused on providing superior security and reporting over the network at the same time as optimizing the network.  As mentioned above, it seems logical to me that high network security would be a key purchasing criterion for network administrators and CTOs.  Although earlier versions of Cisco's product got mixed user reviews, the most recent 4.x release of WAAS has garnered largely positive reviews-suggesting that the product is now fully mature.  According to one integrator/VAR: "We are now seeing a very promising future in Cisco WAAS as it continues to gain significant momentum. This has led to recent success in customer driven competitive bake-offs against the Riverbed Steelhead appliance."


Juniper's product is also making inroads.  Like Cisco, Juniper bough a WAN optimization startup in 2005 and used that technology to launch their own solution, called "WX".  Although the initial product was not successful, customer reviews recently have turned positive.  You can see, for instance, the online discussion here: http://www.networkworld.com/community/node/28157


The effect of this increased competition can be seen in rising marketing costs for RVBD, from 40% of sales in 2007 to 46% of sales in the June quarter.  Despite that investment, RVBD's quarterly product sales peaked at 67 million in Dec and then fell to 60 million in the March and June quarters, with June down 3% year-over-year.  To support RVBD's valuation, you have to believe that product sales will pick up again as economic activity improves.  However, I believe that the downturn has given competitors the time to improve their product and more effectively challenge Riverbed.




Wall Street justifies RVBD's outrageous valuation by pointing to the fact that the WAN Optimization market is huge and growing.  This argument doesn't hold up to scrutiny.  IDC places the WAN Optimization market at $825 million in 2007, over $1 billion in 2008, and then growing to $1.6 billion in 2012.   Riverbed's share has grown to 33% of the market in fiscal '08, but as the market matures, and given the strength of the competition, it's likely their share growth will flatten out.  A  1/3rd market share in a market growing at 12-14% a year is certainly a good business-but disastrous for a company at RVBD's lofty valuation.




Riverbed's CEO Jerry Kennelly's background is primarily on the financial side of the house: he held corporate finance positions at Inktomi, Sybase, and Oracle.  That may be one reason why he's struggled to build an efficient operating organization.  Sales and Marketing, R&D, and G&A expenses continue to be a huge drag on profitability. 


Management certainly isn't sticking with the stock - they have been selling out in droves. The CEO, CFO, SVP of Sales, and CTO have all sold extensive amount of stock in 2009.  See the full detail here: http://www.insidercow.com/history/company.jsp?company=RVBD 




At 172x '10 consensus EPS, Riverbed's valuation is way out of line, even compared with overvalued competitors like Blue Coat.  As competition heats up in '08, the market could cut RVBD's PE back to levels seen by other competitors, which trade at (still inflated) 30-40x forward PEs:


Name Ticker Price FD Shares Mkt Cap '09 Sales Pr/'09 Sales '09 EPS '10 EPS '10 PE
Cisco Systems Inc CSCO $24.25 5818 $141,087 $36,098 3.9x 1.10 1.05 23x
Blue Coat Systems Inc BCSI $25.60 44.59 $1,142 $445 2.6x -0.08 0.43 60x
Juniper Networks Inc JNPR $27.21 532.85 $14,499 $3,183 4.6x 0.43 0.79 34x
Citrix Systems Inc CTXS $42.34 184.74 $7,822 $1,594 4.9x 0.9 1.11 38x
F5 Networks Inc FFIV $42.95 79.61 $3,419 $642 5.3x 1.09 1.25 34x
Riverbed Technology Inc RVBD $24.14 74.67 $1,803 $380 4.7x 0 0.14 172x


At 35x 2010 EPS of $0.14, plus $3.6 of excess cash per share, RVBD would trade at $8.50, 65% below the current price! 




The biggest risk to the thesis is that someone buys RVBD at an insanely overvalued level.  However, at this price you are protected by Riverbed's valuation.  Most acquirers would wait for a drop in the stock before making a play.








Riverbed shows poor topline results in 2H while competitors gain share.  Profitability remains poor and momentum investors abandon the stock.


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