Citrix Goes Virtual

During last summer’s market correction, Citrix Systems Inc. (Nasdaq: CTXS) -- a provider of desktop virtualization, datacenter, and collaboration solutions -- saw its shares drop 43% from a June 1 high of $88.49 to a low of $50.21 in August. After two consecutive quarters of strong earnings, the stock this week moved back above $80 for the first time since July.

At a recent price of $78.40, Citrix trades at 28.6 times the 2012 consensus EPS estimate of $2.74, slightly above the average price/earnings ratio over the past two years and well above this year’s expected EPS growth rate of 10.5%. It’s no surprise then that Nomura Securities this week started coverage of Citrix with a Hold rating based on valuation. The stock is one to watch if we get another correction.

Citrix is a major beneficiary of the massive shift to the Cloud Era from the PC Era, which is expected to fuel a buildout of cloud infrastructure, creating a new market that research firm IDC predicts could top $11 billion in 2014.

Citrix helps enterprise customers transform existing datacenters from rigid cost centers into more elastic private clouds, designed to deliver desktops and applications as services. As the tech sector migrates to the cloud, a wide array of cloud services will emerge, requiring platforms that are built specifically for cloud computing and very different than traditional enterprise datacenters. These platforms must be designed from the ground up to deliver multi-tier, multi-tenant services in the most cost-effective manner.

Last July, Citrix closed its acquisition of Cloud.com, a provider of software infrastructure platforms for cloud providers. The company’s CloudStack product line helps providers of all types build and deploy cost-effective cloud services that are scalable and secure. With CloudStack, a hypervisor-agnostic solution, companies can design their clouds to be as automated and efficient as the largest public clouds. Citrix’s CloudPortal platform turns clouds into revenue generators by helping providers manage pricing, billing, and service provisioning.

Right now, a good deal of Citrix’s growth and valuation is tied to desktop virtualization, which enables enterprises to centrally manage applications delivered from a server to users who access their virtual desktops from any number of thin clients, ranging from “dumb” terminals to laptops and iPads. Nomura estimates that Citrix’s desktop virtualization business, which grew 50% last year, accounts for more than 40% of the company’s current valuation.

In the fourth quarter, revenue from Citrix’s Desktop Solutions unit rose 14% year-over-year to $369 million (representing 60% of total revenue), driven by license revenue growth of 18%. While the company’s core application virtualization product, XenApp, still accounts for about 40% of total revenue and has a nice recurring maintenance revenue stream, it’s not growing as a standalone product because Citrix now includes its functionality as part of XenDesktop, the company’s desktop virtualization offering. First introduced in 2008, XenDesktop, which competes with VMware Inc. (NYSE: VMW) View, accounted for half of the Desktop unit’s fourth-quarter product revenue.

Nomura estimates that only 3% of all enterprise desktops are now virtualized. That low figure could be interpreted bullishly (there is a lot of growth ahead) or bearishly (early adoption has been slow). Nomura argues that desktop virtualization hasn’t gained a lot of traction so far because it does not offer the immediate cost benefits of server virtualization; companies need to buy extra servers, storage, and networking equipment to virtualize desktops, while server virtualization reduces hardware requirements. Nonetheless, Nomura estimates the total addressable market for desktop virtualization at $22 billion and says the segment offers “significant potential” if adoption begins to pick up.

Citrix bulls are counting on desktop virtualization to take off. There are positive metrics: In the fourth quarter, Citrix closed 35 XenDesktop deals worth more than $1 million each with customers in the healthcare, retail, financial services, and government verticals. There were 225 desktop virtualization deals involving 1,000 or more seats, 40 deals covering 5,000+ seats, and 10 deals with at least 10,000 seats.

In the fourth quarter, Citrix’s Datacenter and Cloud unit (17% of total revenue) saw revenue growth of 21%, with license revenue for the NetScaler application delivery controller (ADC), which competes with solutions from F5 Networks (Nasdaq: FFIV), rising 40% year over year. Revenue from the company’s VPX line of virtual ADCs was up 65%. More than 500 XenDesktop deals in the latest quarter included NetScaler, indicating Citrix is benefitting from cross-selling opportunities.

Citrix’s well known collaboration tools, including GoToMeeting and GoToTraining, come under the company’s Software-as-a-Service (SaaS) unit, which makes up 18% of total revenue. These collaboration products, which experienced revenue growth of 29% in the fourth quarter, account for more than half of the company’s SaaS revenue.