Activist hedge fund Elliott Management is shaking things up at Citrix Systems after disclosing a 7.1% stake in the company and offering a plan to create a leaner, meaner Citrix, citing the need for change following “years of layered complexity and expenses.”
Elliott’s proposal (you can see the full text here) comes after increasing speculation about Citrix’s health, with talk of possible takeover and privatization in recent weeks. It is driven by a belief that it can increase stockholder value by approximately 50% to between $90 and $100 per share by the end of 2016. Like it or not, when Elliott talks, CEOs listen, so you can be sure that Citrix CEO Mark Templeton will be looking very closely at Elliott’s recommendations. Citrix stock rose 8% to $71.31 when Elliott’s interest was announced.
Increased competition with VMware is starting to have financial repercussions for Citrix. Earnings (EBITDA) and cash flow (CFOA and FCF) have been declining for several years and reached a five-year low in 2014. With Dell increasing its commitment to vWorkspace, Citrix will face further competitive pressures. Then, there is the growing threat of cloud services of all flavors that increasingly compete with Citrix’s primary markets. It is not just that Citrix faces external competition: when Citrix announced it was cutting 900 jobs at the start of the year it said that this latest restructuring was targeting $90 million to $100 million in annual savings. However, it followed up by announcing in its Q1 2015 preliminary results that it had “underestimated the impact” of this restructuring on revenues. Reported revenue for the quarter was $761 million, well below the company’s guidance of $780 million to $790 million. Then, at Citrix Synergy last month came Templeton’s tacit admission that its customers were not upgrading to XenApp 7.6 and that as a consequence it was extending support for XenApp 6.5 for another year, adding to its operating costs. Extending support for XenApp 6.5 for another year is not just a cost to Citrix: it is also a potential loss. Every customer that has not yet upgraded to XenApp 7.6 is a customer that could transfer its allegiance to VMware or Dell. Here Citrix has to be especially watchful, as the loss of every XenApp customer costs Citrix four times over. There is the immediate loss of software licensing subscriptions, and the potential loss of new license sales, not just for XenApp but for all Citrix products. Then, there is the immediate benefit to its competitors as sales start to benefit them, and finally, the gradual erosion in standing that Citrix would suffer as its market declines. It’s not possible to judge for how long or how fast Citrix will decline, but it is clear that this is a trend line that is not sustainable in the long term. Elliott has taken strong exception to Citrix’s failure to make any substantive changes following poor performance in previous years.
“Over the years, Citrix has recognized that operational changes are needed and that its product portfolio requires rationalization. In 2010, Citrix made promises of ‘efficiency’ and ‘focus’ with the goal of achieving margin targets and rationalizing the portfolio. Unfortunately, these promises were followed by a period of nearly 400 basis points of margin contraction and an expansion into several non-core product categories.
In early 2014, Citrix again made a series of promises to address the operational and share price underperformance. Despite the fact that these promises were nearly identical to the promises made in 2010, many investors and analysts hoped that this time Citrix was finally going to remedy the serious deficiencies in its cost structure. However, operating expenses have continued to outpace revenue growth, and both profit margins and profit dollars have declined over the last 12 months.
It is perhaps because Citrix’s promises have uniformly been followed by increased costs and greater product breadth that the research community maintains a skeptical approach to Citrix and continues to call for organizational change.”
Recent difficulties may in part be due to the eighteen-month leave of absence taken by CEO Mark Templeton after a family tragedy, but this cannot explain all recent problems. Regardless of cause, it is Elliott’s belief that more can be done to benefit the company’s stockholders and is recommending a series of changes.
Elliott’s proposal can be broken down into four distinct thrusts, as follows:
- Streamline sales and marketing
- Slim down the product portfolio
- Sell or spin off as separate businesses NetScaler and the GoTo products
- Cut R&D
Streamline Sales and Marketing
“Citrix’s sales & marketing organization is operating well below industry benchmarks on efficiency and effectiveness, with the weakest metrics among its peers. This is primarily the result of a highly cumbersome and ineffective go-to-market strategy. Critical operational metrics, including the ratios of management positions to quota-carrying reps and sales engineers to field reps, remain out of line with industry best practices. This inefficiency has led to weak productivity per sales FTE and is exacerbated by poor alignment between performance and compensation. In addition, Citrix’s channel strategy is stretched across too many channel partners, with important channel-enablement resources being directed to sub-scale partners.”
This cannot be argued with.
Slim Down the Product Portfolio
“Citrix’s product portfolio is too broad for its scale and contains far too many underperforming product lines that consume valuable resources, have low or negative (i.e., loss-making) return profiles, and serve as distractions. For example, we believe CloudBridge, CloudPlatform and ByteMobile are non-core, are underperforming and are distractions to the management team. We believe these businesses, particularly ByteMobile, should be sold or realigned.”
Citrix currently lists thirty-eight products in its portfolio. This list still includes AppDNA and VDI-in-a-Box, but for the moment it omits anything from Octoblu. Highlighting Octoblu is deliberate. It is, by Elliot’s measure, non-core, underperforms, and is a huge distraction to the management team. It is also the future. To simply say it underperforms is no way to determine what should stay and what should go. CloudBridge, which provides WAN virtualization, and CloudPlatform, for cloud orchestration, are very clearly non-core, until you look at them in the context of Citrix’s Workspace Cloud ambitions, where apps and desktops can be hosted anywhere and orchestration services are central to its ability to implement next-generation application and desktop hosting services. If Elliott wants Citrix to focus on its core, it must first understand what that core is—in terms not of where it was, but of where it is going. There’s no point optimizing Citrix to compete in 2012. This is not to say that all Citrix products should be sacrosanct. I struggle to understand the importance of the Grasshopper virtual phone system: cool, yes, but relevant? The same goes for Podio, a platform for building social collaboration workflows, and Concierge, a customer service and support platform for mobile and web apps. They seem to fit nowhere.
NetScaler and the GoTo Products
“Citrix possesses high-value, strategic assets that we believe can be separated from the core Workspace Services segment: the GoTo franchise and NetScaler. Such separations would not only be meaningfully accretive to value but also would enable Citrix management to focus on improving the Company’s core operational execution… While we recognize the broad notion of empowering a mobile workforce, this business’s go-to-market strategy, product development roadmap and end-market are absolutely distinct from the core of Citrix… NetScaler is an excellent business, and its ADC technology is an industry-leader; however, we believe Citrix has overly relied on the virtualization cross-sell, resulting in significant under-penetration in non-virtualization use-cases and within the telco vertical.”
Elliott stops short of saying “Sell GoTo and NetScaler,” but makes it clear that its goal is to see the back of them one way or another.
Elliott’s assessment of Citrix’s Citrix Online go-to-market strategy, product development roadmap, and end market are quite fair. When Citrix first acquired Expertcity, its stated strategy was explicitly to keep the GoTo products at arm’s length from XenApp, a strategy that has remained unchanged, even when Citrix Online products were offered as components of the XenApp Platinum Edition. As a consequence, there is no single grand plan for Citrix Receiver to function as endpoint to both XenApp and GoToMyPC. The product has its own remote display protocol, with separate feature sets and development teams. Reassessing this approach might be better for both in the long term than to take a quick fix and spin it off or sell it.
Elliott’s biggest concern about NetScaler is its belief that “Citrix has overly relied on the virtualization cross-sell” and as a consequence has failed to achieve expected penetration in non-virtualization use cases, such as within the telco vertical. Citrix has seen considerable success with NetScaler, far beyond the ability to cross sell into XenApp/XenDesktop accounts; revitalizing its channel to better target telcos may be all that is required. The fact that Citrix also offers Content Delivery Analytics, a turnkey content delivery network (CDN) analysis package, strongly suggests that Citrix understands the value of these solutions; it just lacks the ability to sell them. Setting aside that possibility, cutting NetScaler loose could significantly improve NetScaler sales, but it has to be acknowledged that it will do nothing to help XenApp/XenDesktop sales. While Citrix has never fully exploited the potential of NetScaler as an integral part of XenApp/XenDesktop, knowing that Citrix has a fully supported application delivery controller to manage access to XenApp/XenDesktop gives it a significant edge over VMware Horizon. Take this away and the incentive to choose Citrix for workspace virtualization only weakens it. So, while the positions that Elliott puts forward appear to be valid, as a rescue package, selling off the product lines that are not under immediate threat from Citrix’s biggest competitor and hoping for the best is less than ideal. A short-term gain by selling off NetScaler would inevitably be followed by a long-term decline.
Research and Development
“Citrix’s product development effort needs a full operational review with strong cross-functional participation. The recent product-release issues in both XenApp and XenDesktop, marred by critical feature gaps from prior versions, had a deep impact on execution over the last several years and demonstrated a disconnect between customer requirements and development roadmaps. In addition, Citrix’s recent history of funding speculative R&D initiatives without clear route-to-market or tangible competitive advantage must be reevaluated immediately. These speculative or non-core projects need to be scaled back or eliminated and resources reallocated to the product categories where Citrix has the greatest likelihood of success. Return-on-investment project tracking with a focus on risk-adjusted returns needs to be implemented and strictly followed.”
Elliott is right to criticize Citrix’s failure to deliver a feature complete XenApp 7.5, although whether this was due to a disconnect between customer requirements and development roadmaps or was a response to the size of the task is debatable. Its position on speculative R&D initiatives is troubling. Cutting back on R&D may save money and fulfill Elliott’s goal of raising the stock price in the short term, but it is harmful to the company’s long-term prospects. It may be consistent with a Citrix focused around XenApp, XenDesktop, and XenMobile, but it doesn’t bode well for the company whose main advantage over its primary competitor is its ability to create new ideas. Mortgaging Citrix’s future may create a win for Elliott, but it cuts deep at everything that Mark Templeton has achieved in the last twenty years.
What is missing here is any mention of Octoblu. This is perhaps the most significant area of concern in all of Elliott’s proposal. Did Elliott ignore it because it views Octoblu as irrelevant? Has it pigeonholed it as a few new features that will appear in Citrix Online products at some point in the future, thinking that whatever the future holds in store for the GoTo products will also be Octoblu’s fate, or did it make the decision before it became clear that Octoblu was central to Citrix’s future growth? Whatever happens, you can be sure that Templeton’s opinion will weigh heavily on the ultimate decision. He is immensely well respected both within Citrix and in the industry as a whole, and that might be enough for him to weather the storm and rely on his past successes to allow him to ride out what I expect will be two or three rough years.