Juniper Networks Stock: Fairly Priced Given Some Regulatory Risk (NYSE:JNPR)

Juniper Networks shares (NYSE:JNPR) have been solid performers over the past year, thanks to the company’s announced acquisition by Hewlett Packard Enterprise (HPE) for $40 in cash. Shares are now about 3% below levels reached immediately after the deal was announced. They are about 8.6% upside from the $40 deal price at current trading levels, given the continued scrutiny of the deal by regulators. To determine whether investors should hold the stock for the remaining upside, we need to consider the chances of a deal and where Juniper’s standalone fundamentals would leave the stock trading without the deal.

Will the transaction be completed?

Juniper has stopped giving financial guidance or holding earnings calls, as is common, in connection with the pending acquisition. In its first-quarter earnings report, Juniper said it expects the deal to close in late 2024. or early 2025.In the event that HPE does not obtain regulatory approval, HPE will pay Juniper a termination fee of $815 million. There have been a number of regulatory actions that indicate the deal is subject to some scrutiny. I believe they are consistent with a deal of this size.

In May, the Justice Department filed a second request for information suggesting the deal is subject to significant antitrust scrutiny. The U.K. has also opened a preliminary investigation into the deal, and we will know by mid-August whether it will pursue a more vigorous investigation. By Aug. 1^saintThe EU will have to determine whether an in-depth review is necessary or whether it can approve the deal outright. Given the heightened scrutiny in the US and UK, I would expect Europe to fully scrutinise the deal.

Crucially, it doesn’t appear that China will need to approve the deal. Given the heightened geopolitical tensions, there would be a non-zero risk that China would block the deal given the involvement of U.S. companies, regardless of antitrust concerns, as QUALCOMM (QCOM) found out in its failed takeover attempt on NXP (NXPI) a few years ago.

I believe that US and EU regulators are the most important decision-makers. Last year, we saw the UK wait the longest to approve Microsoft’s (MSFT) purchase of Activision, but ultimately it is unlikely that it will stand alone to defy its key allies and trading partners and block a deal that would otherwise have been approved.

Given that Juniper offers ancillary products and is not a direct competitor to HPE’s offerings, HPE does not foresee a significant antitrust obstacle. Given HPE’s current market capitalization and debt load, the combined company would have an enterprise value of only about $50 billion. That’s about a quarter of the size of IBM (IBM), 30% of Cisco Systems (CSCO), and a fraction of the multitrillion-dollar “Big Tech” companies that dominate much of our lives and our stock market. Indeed, allowing HPE to grow a bit could actually help it compete better with larger players and increase competition.

I think the deal is more likely to close than not, given its size and the fact that JNPR’s networking and cloud offerings are largely complementary to HPE’s own products. It will still have a smaller market share than companies like Cisco and larger cloud players like Oracle (ORCL), which should mitigate antitrust concerns. Even with the current DOJ, I expect the U.S. to approve it. It’s possible that if Donald Trump wins the election, DOJ turnover could delay approval, but I wouldn’t expect his administration to take a tougher stance on antitrust issues than the Biden administration.

As such, I would classify this acquisition as “more likely than not” to close, although it is not a complete certainty. I would also expect it to close in late Q1 2025 or toward the end of Juniper’s expected closing timeline, given regulatory review. I believe the deal has a probability of close of about 80%, but my fair value analysis below shows returns with a probability of 50-90% for investors with a range of views.

The Value of Juniper as a Standalone Company

Now we know that investors will receive $40 if the acquisition is completed. The question is how much Juniper will be worth if the deal is blocked. I see some downsides, and recent results have not been encouraging. In the first quarter, the company’s revenue fell 16% to $1.15 billion. Non-GAAP earnings per share were $0.29, and net income fell 38% to $97 million.

Product revenue fell from $913 million to $652 million. Services revenue increased 8.3% to $497 million. This change is somewhat positive, because while product gross margins are around 50%, services gross margins are over 71%. Still, the scale of the decline in product sales is significant. Management sees macroeconomic headwinds weighing on customers, while other customers are processing last year’s shipments before they need to place new orders. It sees growth in cloud offerings, with Mist seeing double-digit growth.

Juniper’s product side is suffering from the “whiplash effect.” COVID supply chains have delayed shipments, and given the surge in network usage as work has gone remote, demand has spiked. JNPR eventually managed to fulfill those orders by last year, but after meeting demand, there’s now limited demand for new product. Service provider revenue has been hit particularly hard, down 31% to $382 million. Its services business continues to grow, but product is likely to be a drag for several quarters.

I was particularly encouraged by the fact that service costs fell $1.6 million despite revenues up $38 million, which speaks to the scalability and huge margins of this business line. Unfortunately, given the scale of the decline in product demand, adjusted operating margins fell to 10.6% from 14.8%. Even with lower revenues, sales and marketing rose just under 1% to $305 million, and R&D rose 4% to $297 million.

Frankly, the company is not showing much cost discipline given this revenue decline. I would also like to note that inventory increased by $6 million to $958 million, a worrying sign that demand has slowed even more than the company had anticipated. I suspect that JNPR management is holding off on taking significant cost actions given the pending acquisition, which is why HPE sees synergies in the hundreds of millions.

If a deal falls through, we’ll likely need to make significant cost-cutting efforts as these product cycles may take some time to normalize. Plus, as we’ve seen in other tech earnings reports like Salesforce (CRM), tech budgets may be shifting from legacy products to AI, and this cannibalization could further slow JNPR’s recovery.

It’s also worth remembering that JNPR hasn’t exactly been a growth stock for some time. As you can see from Seeking Alpha’s financial dashboard below, the company hasn’t really grown much over the past decade. Revenue grew last year as it fulfilled orders, but we’ll likely end the year below $5 billion, similar to 10 years ago. With major telecoms also struggling with large debt loads, I expect service provider revenue to remain subdued as significant cap-ex expansions are unlikely.

Free cash flow growth was similarly subdued at approximately $500 million per year, with wide fluctuations, primarily due to changes in working capital.

Now, on the positive side, JNPR has a strong balance sheet with about $1.25 billion in cash and $1.6 billion in debt. With the $815 million it would also receive if the deal falls through, JNPR would have a net cash position. This comfortably protects its 2.4% dividend yield. While share repurchases are suspended pending the HPE acquisition, they are likely to resume immediately following the deal failure.

In Q1, JNPR generated $190 million in free cash flow, excluding working capital. Now $80 million of that is stock-based compensation. I consider that a cash outlay because it’s simply diluting shareholders. True “free cash flow” is ~$440 million. As a standalone entity, I would expect it to reduce costs, and even with muted product sales, it’s probably a ~$600 million cash flow business after significant SG&A reductions.

Application

Below I value JNPR in both scenarios. Given the slow growth, I value JNPR at 6% free cash flow and added ~$400 million net cash for a standalone value of $32.20. Investors will also receive 3 dividend payments through March 31, 2025. Basically, I see about a 14% annual gain if the deal closes and a 14% loss if the deal falls through. With an 80% chance of a deal happening, investors have a likely annual return of 8.5%.

Now, this 8.5% return would be relatively uncorrelated to overall market performance since it is closely tied to regulatory approval and the $40 is paid in cash and not HPE shares. Generally, I would see ~8% as the market return to justify a “hold” recommendation, and 10%+ would justify a buy. At my 80% trade probability, JNPR is definitely a “hold” and investors would need to see a trade close as closer to 90% probability to justify a buy here. Now, these returns are quite sensitive, if the stock were to fall to just $36.44, the weighted return would be my 10% buy threshold.

The market currently seems to be pricing in a ~80% chance of the deal closing, which seems about right to me. As such, I don’t see JNPR as a compelling merger arbitrage buy given its weak standalone fundamentals. For the same reason, there’s also no need to sell the stock. I see the stock as a “hold.” While I think investors will likely get $40, the risk of the deal falling apart keeps me from rating JNPR as a buy. If we saw the stock fall to $36 on more regulatory headlines, I’d consider buying, but closer to $37, I don’t see a rush to buy.