Wednesday, January 16, 2013

Citrix Systems Equity Research and Analysis

The last six months have been a tricky time for tech investors. The economy slowed and corporations did what they always do in such circumstances. They held back capital spending on IT or reduced the scale of it wherever they could. As such, Citrix Systems (NASDAQ: CTXS) is rather typical of this trend. The question is whether it is time to buy back into these sorts of tech names or not.

It’s Not You, it’s Me

Naturally, anyone who has ever been fed this line knows that it is complete nonsense. In a similar vein, whenever there is a general slowdown in tech spending it seems to affect the whole industry's new product sales. However, analysts and commentators always take it upon themselves to look at one company in isolation and conclude that its particular niche is in trouble while ignoring the big picture.

IBM (NYSE: IBM) kicked off the tech bellwether earnings season last time and referred to orders turning very weak in September. In IBM’s case, its hardware sales were a disappointment while services and software did okay. I discussed this in more detail in an article linked here. This sort of pattern indicates a reluctance of customers to commit to capital outlays and was probably caused by worries over the ‘fiscal cliff,’ the election, the changing regime in China and ongoing European difficulties.

However, three of those four issues (particularly in Europe) have seen a lot of positive news recently, which is why investors’ thoughts should turn to technology. For example, here is how the slowdown in customer sentiment hit Citrix.

Here are the revenues from the three big segments:




Note the weakness product and license revenue growth. They slowed to .9% annual growth in Q3, and while it only makes up around 30% of revenues, it is the key to future growth in the other revenue streams.

So How Did Citrix Guide?

This pattern is not unusual. From Check Point to Oracle to Ciena, whole swathes of technology companies have seen slower spending commitments from customers. It isn’t anything industry specific, and I’m sure this is not a sign that desktop virtualization is a slowing marketplace. The key is to ascertain whether current expectations are too high or not.

Here is the historical total revenue for Citrix plus the mid-point of the $700-710 million forecast by the company for Q4 at the last results.




Now given that the rest of the business is doing fine the key question is over product and license revenues. I’ve done some back of envelope calculations, and I think Citrix’s guidance implies a re-acceleration in product revenues back to around 5.5% growth.  On an optical level (first chart) I think it’s possible but analysts with a join-the-dots mentality will require more evidence.

My suspicion is that the latter may hold sway and this is probably the reason why the stock has been sold off in the latter part of the year.

Citrix’s Growth Slowing?

It would be churlish to ignore the possibility that this is a Citirix issue. However, I think desktop virtualization has plenty of good growth drivers behind it.

  • Bring Your Own Device (BYOD) growth and increasing use of work tablets is forcing companies to increase virtualization across all platforms.
  • Security issues are alleviated by shifting apps to the data center.
  • Microsoft’s (NASDAQ: MSFT) Windows 8 upgrade will cause lots of compatibility issues, which are alleviated by using desktop virtualization.
  • Virtualization means companies infrastructure can be more easily integrated when mergers and acquisitions take place.
  • Clients IT downtime is reduced via the virtualization model.

In fact the cross benefits of Citrix and Microsoft run deep, as they integrate the functionality to use each other’s technologies through their respective solutions. While it looks unlikely that Windows 8 is going to be the blockbuster driver of new hardware purchases that many were hoping it to be, its planned integration into existing hardware may increase interest in Citrix’s solutions. Customers may well just decide to go with virtualization rather buy new hardware.

Citrix is also partnered with Cisco Systems (NASDAQ: CSCO) and recently announced plans to invest in joint solutions in the mobile-cloud area. This sort of thing is much needed for Cisco, a company that has made some disappointing investments in acquisitions over the last few years. The possibility of a Cisco buying Citrix down the line is an obvious outer but I think Citirix is attractive enough without worrying about takeover speculation.

The Bottom Line

In conclusion, Citrix has some very powerful partners who share its growth intentions, and it also has strong end market drivers. The near term concerns are over the slowing product and license sales and whether this is macro related or Citrix. Furthermore, Citrix’s guidance looks optimistic in light of the last few quarter’s results.

On balance, I think the company can be given the benefit of the doubt for now, and the current price may prove an attractive entry point in years to come. The move towards desktop virtualization isn't going away. I know everyone focuses on the PE ratio, but its cash flow generation is superb. On a rolling basis it has generated nearly 5.5% of its enterprise value in free cash flow. That’s good enough for me, especially with a company forecast to grow earnings in double digits in the next couple of years. I will look to pick some up.