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F5 Is Widening Its Competitive Advantage

Customer switching costs will keep rivals at bay.

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F5 Networks (FFIV) has effectively leveraged its first-mover advantage in server load balancing to build a business that possesses structural competitive advantages, primarily customer switching costs. Its financial performance rivals that of dominant software vendors. F5 generates very high returns on capital thanks to the significant amount of software content embedded in its appliances, its large base of high-margin maintenance service revenue streams, which are recurring in nature, and the relatively small amount of capital needed to run the business. F5's stable and strong market share, increasing customer penetration, and strong services revenue growth also point toward a narrow economic moat. Although we recently upgraded our moat rating to narrow from none and increased our fair value estimate to reflect our more optimistic long-run view of the business, we believe the shares are currently overvalued.

F5 Is Essentially a Software Company
F5's products, services, and business model support industry-leading returns on invested capital. F5's core products are its application delivery controllers. ADCs can perform a variety of tasks related to delivering and securing software applications, but their core function is server load balancing. This process distributes traffic load more evenly across Web servers to ensure that the end user receives the best experience possible when visiting a website or using a software application.

Grady Burkett does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.

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