Tech Beat: Two networking gear IPOs show promise
Understanding the promise of the two companies profiled in this week’s column requires a little context on the way communications has evolved over the past several decades.
Before the Internet, telephones were the best way for long-distance communication (meaning, of course, any distance beyond ear shot), and the same basic group of companies such as Nortel Networks Corp. (NYSE: NT). and Lucent Technologies Inc. did a great business selling the same basic telephone equipment to service providers year after year.
The rise of the Internet then gave rise to companies like Cisco Systems Inc. (Nasdaq: CSCO), which makes gear that connects and enables communications between computers.
Internet and telecom might have remained two distinct industries, except that telecommunications started evolving too. Cell phones gave way to mobile communications and improving phone and Internet technology made it possible to do more than just talk over phones.
Today, talking over phones, particularly cell phones, is going out of style as more and more people prefer to send text messages or use their smart phones to play games, download music and watch video.
All of the old telecom equipment providers like Nortel and Lucent, today a part of Alcatel Lucent (NYSE: ALU), are trying to compete in this market for new networking gear to enable better mobile and broadband communications. This equipment, though, is so different from the so-called legacy gear they traditionally sold that they are often regarded as dinosaurs challenged to compete with a crowd of startups that more fully understand modern communications.
Case in point: Alcatel Lucent (ALU), a company formed last year through the merger of two of the world’s largest telecom gear makers, earlier this month issued its third revenue warning in less than a year and said its business was struggling.
Although the networking gear startups Airvana Inc. (Nasdaq: AIRV) and Veraz Networks, Inc. (Nasdaq: VRAZ), which both went public this year, must compete with far larger players, they are innovative and nimble and show great promise.
Airvana Inc., a Chelmsford, Mass.-based maker of technology that is used to deliver mobile broadband services, had a weak debut when it went public in July at $7 per share, below the expected range of $8 to $10. Since then, it has traded as high as $8.35 but has tended to trade below its IPO price. After touching a low of $5.03, it now sells at around $6.55 per share.
Despite this less than stellar stock performance, there have been several signs suggesting that Airvana’s business is set to grow over the long term. Its revenues in fiscal 2006 rose to $170.3 million from $2.4 million the year before and it was solidly in the black with a net profit of $74.1 million, compared with a $63 million loss the year before.
That growth trend continued in the company’s most recent second quarter, when it showed revenues of $156 million and net income of $85.1 million.
One of the main issues that has kept investors cautious with this stock is the fact that it derives virtually all of its business from Nortel Networks Inc., itself a struggling company.
But Airvana has been working hard to diversify both its product line and its customer base, and it is making progress. Earlier this month, it formed a partnership with Nokia Siemens Networks Inc. to jointly develop a critical piece of equipment known as a femto cell, which essentially provides a shortcut for phone service providers to deliver more services beyond voice without extensively overhauling their entire networks. Nokia Siemens estimates that the market for this equipment is nearly doubling on a yearly basis.
In addition, Airvana earlier this year acquired the British company 3Way Networks Inc., which it said would also help it diversify its product line.
Analysts are optimistic. In late August, Jeffrey Kvaal of Lehman Bros. put a price target of $8.50 on the stock, saying he expected it to start to win more contacts as the market for mobile data and applications grew at a rate of at least 50% a year.
Morgan Stanley’s Scott Coleman, meanwhile, has a $10 price target on Airvana.
“We view Airvana as a core holding for investors seeking exposure to wireless broadband and believe the valuation is too cheap to ignore,” he wrote in a research report.
Like Airvana, San Jose, Calif.-based Veraz Networks Inc. had a weak IPO this past April, when it opened well below a set range and then drifted lower. But this company, which makes gear to help service providers deliver more advanced consumer services, is also starting to look like too good a bargain to pass up.
The company’s stock now sells for about $6.62 per share, and has sold in a range of $5.25 to $8.19 since going public. Last year, its revenues grew to $99.7 million from $76.2 million the year before, while its net loss narrowed slightly, to $13.9 million from $14.3 million in fiscal 2005. In August it reported a quarterly net profit of $2.1 million and analysts see strong future growth.
A group of five analysts is forecasting a net profit of $0.10 per share this year and $0.32 next year, and projecting that revenues will grow to $125.8 million this year and $158.2 million next year. In August, FTN Midwest Securities initiated coverage of Veraz with a “buy” rating.
In at least one respect, Veraz is very different from Airvana. Its client base is highly diversified, not only among customers, but among countries. Veraz sells a lot of its equipment into emerging markets such as Russia, Brazil, India, Indonesia, Pakistan and Vietnam, where it has found brisk demand and less competition than in many industrialized nations.
Although it won’t be able to keep the competition at bay forever, its strategy of global diversification has earned it a valuable head start. Investors looking for good buys in the busy telecom and networking gear sector should look closely at these two companies.
