F5 Inc

F5 reported strong third-quarter results, with the firm's sales increasing by 11% to $865 million and its adjusted operating margins expanding 70 basis points to 35%. Management raised its fiscal 2026 sales growth outlook to 9.5%, up from 7.5%, at the midpoint of the guidance ranges.

Why it matters: F5's hardware business continues to benefit from artificial intelligence-driven tailwinds. As inference demand continues to scale and enterprises work through agent deployments, F5's load-balancing appliances are well-positioned to handle this high-volume traffic while maintaining low latency. Last quarter, the firm reported it had around $50 million in direct AI-related sales in the first half of 2026, up more than 200%. This quarter, they noted that its customer count for AI use cases grew 50%. While these numbers are recent and the high growth reflects the relatively small base they're growing from, it is still fair to say that F5 is seeing tangible AI benefits on its top line, a trend we expect to continue over the next few years as AI deployments grow.

The bottom line: We raise our fair value estimate for narrow-moat F5 to $400 from $366, driven by better-than-expected results and guidance, as well as an uptick in our longer-term estimates. We see shares as currently fairly valued. On the margin front, we were impressed to see adjusted gross margins expand by 110 basis points, driven by F5's ability to sell more premium appliances to enterprise customers.

Coming up: Alongside raising guidance for fiscal 2026, the firm also provided a preliminary outlook for 2027 software sales, which it expects to accelerate to double-digit growth primarily due to a strong three-year renewal cohort from 2024. With software sales reaccelerating and hardware sales staying strong due to AI, we believe the company's product sales will reaccelerate to 18% in 2027, up from an estimated 17% in fiscal 2026.

Our fair value estimate of $400 per share for F5 is equivalent to an enterprise value/sales of 6 times and a free cash flow yield of 3% for fiscal 2026.

Our expectation is for a five-year revenue CAGR of 9%. We expect a combination of cyclical and secular demand drivers to power this growth, which is above the firm's historical three-year and five-year top-line growth rate.

On the cyclical side, we are seeing very strong renewals in hardware (systems). Customers are not simply replacing end-of-life appliances but upgrading to higher-capacity, higher-performance systems to support hybrid and multicloud architectures and AI-driven workloads. Within the hardware ecosystem, we see the rSeries appliances and Velos systems as clear beneficiaries of this hardware refresh cycle, which we expect to continue into fiscal 2027.

Further, software revenue growth should reaccelerate in fiscal 2027, driven by the renewal of a significantly larger installed base. We'd remind investors that fiscal 2027's renewals roll against the fiscal 2024 cohort as software contracts are three-year, when software sales grew 11%. This comparison is juxtaposed with fiscal 2026 renewals, which rolled against the flat fiscal 2023 base.

On the secular side, we believe F5's cloud-agnostic architecture is critically important in a world where the vast majority of enterprises are running their infrastructures using a hybrid and multi-cloud model. Second, we believe the security F5 offers on top of its appliances is set to become more important, especially as agentic AI and inference compute drive demand for runtime and API security. Third, as inference compute scales, so does demand for F5's load balancing and AI routing solutions that are optimized for low latency and high throughput.

On the mix front, we are expecting the firm's strength across hardware and software to drive products higher as a percentage of total sales. We expect product contribution to sales to grow to 63%, up from 54% currently. As the mix shift leans away from high-margin services to comparatively lower-margin products, we model efficiency and scale-led margin expansion to be offset by this mix shift, leading to flattening gross margins over the next five years at 81%. On the operating margin front, we model F5's revenue growth rate to outpace operating expenditures growth, and we foresee operating margin expanding to the mid-30% range in fiscal 2030 compared with 25% in fiscal 2025.

We assign F5 a narrow economic moat rating based on strong customer switching costs and intangible assets. F5’s switching costs stem from the critical nature of its ADC offerings that safeguard application deployment, security, and optimize network traffic flow. We also view intangible assets as a secondary moat source, exemplified by F5’s strong reputation developed from long-term product design expertise and innovation that allow for pricing premiums. With strong recurring revenue metrics coupled with sticky products and software growth, we anticipate F5’s competitive advantages will allow it to produce excess economic returns over the next 10 years.

F5’s building blocks begin in the late 1990s with load-balancing products that were critical for managing server workloads by optimizing response time and avoiding overloading compute nodes within data centers. F5 then developed more advanced application delivery controllers, or ADCs, that performed load-balancing duties coupled with critical network optimization and security for enterprises. Since F5’s initial ADC offering, its products have expanded into a complex family of software and hardware solutions including, but not limited to, web application firewalls, or WAFs, global and local traffic management, analytics, and secure web gateways.

We believe that F5 benefits from high customer switching costs most prominently in enterprises and government entities, as any network downtime or security risk associated with switching from one vendor to another could cause significant disruption risk. The two verticals combined for about 86% of F5’s total bookings in fiscal 2021.

We believe F5’s products are inherently sticky in both hardware and software. Hardware requires installation, training, is time consuming, costly to remove, and can cause operating interruptions when replaced. Software products have contracts, require training, and updates are provided throughout the lifecycle. We think F5’s product stickiness is exemplified by recurring revenue trending up to the low-70% area and subscriptions accounting for around 80% of its total software revenue. IT teams are increasingly focused on using more applications and software through public clouds and software-as-a-service, or SaaS, vendors. This has resulted in less ADC hardware revenue due to less network traffic and application management occurring on-premises. To adapt and grow with the transition, F5 has over 90% of its engineers focused on developing software products, SaaS offerings, and managed services. Overall, we view this shift from hardware to software as a net neutral for customer switching costs on its own and a positive when considering bundled offerings that further entrench customers into the F5 ecosystem.

F5’s services segment also lends itself to a switching costs moat source due to the complex nature of ADCs that require upfront training and allow for upgrades, customization, and new iterations throughout the lifecycle. This prevents F5’s products from getting stale and having to be frequently replaced. Services have long generated over 50% of F5’s total revenue, although that figure is trending down as software currently results in less services revenue.

Additionally, F5 has developed its intangible assets moat source through its strong reputation among IT professionals. We believe its products are considered best in class, innovative, and reliable, all of which makes F5 a top choice for an essential part of modern businesses. Although intangible assets are a secondary moat source, we think the company’s reliable reputation is critical as risk aversion plays a factor in application delivery controller purchasing decisions. F5’s steady track record allows it to win new business and, thus, benefit in later years by being entrenched with sticky customers. Pricing power is inherent to products that are vital to keeping a business running smoothly, which in turn makes production downtime risk aversion a key purchasing factor.

F5’s sticky products coupled with its strong reputation allow for recurring revenue and pricing power that should lead to higher margins and returns on invested capital. Competition will remain strong and will likely increase with larger players entering the market. Presently, Amazon AWS is the slight overall ADC market share leader helped by its strong AWS brand and capitalizing on recognizing the shift to cloud environments. Competition remains stiff in the software ADC field with the like of Microsoft and Alibaba entering the fold. However, these newer entrants do not offer enterprise-class products like F5 and in the cases of Amazon and Microsoft, only offer products that can be used within a specific cloud infrastructure.

F5 is infrastructure agnostic, enabling deployment across different environments. As F5’s market share has been chipped away, it has focused on increasing its total addressable market. This has resulted in SaaS and edge application security acquisitions. We think that F5 will increase its share in a declining hardware market and remain the second largest overall provider, necessitating its increased focus to more pure security offerings. Recurring revenue from subscriptions should help buoy F5’s margins and increase the stickiness of its products. The networking traffic environment will continue to develop, but we now view F5 as well positioned to adapt and succeed in a changing environment. As such, we believe in F5’s ability to generate excess returns above its cost of capital over the next 10 years.

F5's leading install base could make it the first choice for customers pursuing the high growth areas of software and cloud-based solutions for application and traffic management.

A strong brand coupled a very sticky services businesses may ward off potential open source or lower cost standardized software-based threats. F5 has key technology alliances with networking and data center providers.

Data proliferation and complexities through 5G and Internet of Things offers strong growth possibilities as customers may require a seasoned application delivery vendor.

Customers may forgo F5 products as their workloads are deployed into cloud environments, which shrinks F5's addressable market.

Hyperscale cloud providers could be F5's largest competitors, and F5 has a fraction of the resources possessed by the likes of Amazon, Microsoft, and Google.

Open-source solutions can typically be consumed for a lower price than branded F5 products. If F5's services do not carry clout with customers, revenue and margins could be at risk.