Here ya go.
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08:34am EST 10-Dec-99 Merrill Lynch (J.Osha (1) 212 449-0930) VTSS
VITESSE SEMICOND:LUcent concerns overblown-raising opinion
ML++ML++ML Merrill Lynch Global Securities Research ML++ML++ML
VITESSE SEMICONDUCTOR CORP. (VTSS/OTC)
LUcent concerns overblown-raising opinion
Joseph Osha (1) 212 449-0930
BUY
Long Term
BUY
Reason for Report:Company Update
Price: $46 1/2
12 Month Price Objective: $63
Estimates (Sep) 1999A 2000E 2001E
EPS: $0.42 $0.68 $1.07
P/E: 110.7x 68.4x 43.4x
EPS Change (YoY): 57.1% 53.0%
Consensus EPS: $0.66 $0.93
(First Call: 25-Nov-1999)
Q1 EPS (Dec): $0.10 $0.14
Cash Flow/Share: $0.57 $0.78 $1.17
Price/Cash Flow: 81.6x 59.6x 39.7x
Dividend Rate: Nil Nil Nil
Dividend Yield: Nil Nil Nil
Opinion & Financial Data
Investment Opinion: C-2-1-9 to C-1-1-9
Mkt. Value / Shares Outstanding (mn): $7,859 / 169
Book Value/Share (Sep-1999): $2.96
Price/Book Ratio: 15.9x
ROE 2000E Average: 18.4%
LT Liability % of Capital: 0.0%
Est. 5 Year EPS Growth: 38.0%
Stock Data
52-Week Range: $55 3/8-$19 7/8
Symbol / Exchange: VTSS / OTC
Options: None
Institutional Ownership-Spectrum: 70.4%
Brokers Covering (First Call): 17
ML Industry Weightings & Ratings**
Strategy; Weighting Rel. to Mkt.:
Income: Underweight (07-Mar-1995)
Growth: Overweight (13-May-1999)
Income & Growth: Overweight (13-May-1999)
Capital Appreciation: Overweight (10-Feb-1999)
Market Analysis; Technical Rating: Above Average (25-Jun-1999)
**The views expressed are those of the macro department and do not necessarily
coincide with those of the Fundamental analyst.
For full investment opinion definitions, see footnotes.
Investment Highlights:
o We hosted an upbeat meeting with Vitesse's CEO yesterday. We came away
feeling that concerns regarding business trends at Lucent were overblown, and
that the company would likely beat our FY00 and FY01 estimates.
o We are increasing our EPS estimate for FY00 from $0.66 to $0.68, our FY01
estimate from $1.01 to $1.07, and are raising our opinion from an Accumulate /
Buy to a Buy / Buy.
o We are increasing our price objective from $58 to $63, based on 22 times
CY00 sales.
Fundamental Highlights:
o We expect Dec. quarter revenues from Lucent to increase by 12%
sequentially to $16.4 million.
o The company's Colorado Springs fab is now operating at 60% of its
installed capacity. We also believe that the company is seeing yields from the
fab which are higher than originally expected.
o Based on improving yields, we are increasing our FY01 gross margin
estimate from 65.0% to 67.0%. Our FY00 gross margin estimate has been raised
from 64.7% to 65.2%.
o We anticipate an upbeat Dec 99 qtr earnings call.
Upbeat Meeting With The CEO
We hosted an upbeat meeting with Vitesse's CEO yesterday. We came away feeling
that concerns regarding business trends at Lucent were overblown, and that the
company would likely beat our FY00-01 estimates.
We are increasing our EPS estimates for FY01 from $1.01 to $1.06, and are
raising our opinion from an Accumulate / Buy to a Buy / Buy. We are also
increasing our price objective from $58 to $63, based on 22 times CY00 sales.
Business trends at Lucent positive
We believe the stock has underperformed its peers recently due to a number of
concerns with the company's largest customer, Lucent. We review each in
turn.
1. Transition to contract manufacturing. Lucent recently transitioned
some of its manufacturing operations to contractors, which resulted in flat
revenues from Lucent during the past two quarters. We believe that this
transition is complete, and expect revenue growth from Lucent to return to
historical levels.
2. Lucent Microelectronics. There have been concerns in the investment
community that Vitesse has been losing a material portion of its business at
Lucent to Lucent Microelectronics. Based on our conversation with management,
we do not believe there is a material change in the competitive environment at
Lucent.
3. Inventory build. Some investors are concerned that Lucent is building
inventory to protect against Y2K supply-chain disruptions, which could result
in an order shortfall during the March '00 quarter as inventory returns to
normal levels. Vitesse management indicated that components shipments to
Lucent are driven by the company's MRP plan, which means that products shipped
to Lucent are replacing products that have been used to manufacture equipment.
While it is not clear whether or not finished goods inventory is being built,
shipping products based off of the MRP build plan suggests that component
inventory is not being built.
A review of these issues suggests that concerns regarding business trends at
Lucent are overblown. In fact we expect Dec. quarter revenues from Lucent to
increase by 12% sequentially to $16.4 million.
Increasing gross margin and EPS estimates
On the operational side of the business, the company's Colorado Springs fab is
now operating at 60% of its installed capacity. We also believe that the
company is seeing yields from the fab which are higher than originally
expected.
Based on improving yields, we are increasing our FY01 gross margin estimate 200
basis points from 65.0% to 67.0%. Our FY00 gross margin estimate has been
raised as well, from 64.7% to 65.2%. The gross margin improvements should flow
to the bottom line, and we are increasing our FY01 EPS estimate from $1.01 to
$1.07. Our FY00 estimate has been raised from $0.66 to $0.68.
Buying opportunity - raising opinion
The fundamentals for Vitesse continue to look solid. For FY00, we are modeling
revenue growth of 52% in the transmission business, and 77% in the gigabit
Ethernet and fibre channel business. We believe there is upside to our gigabit
Ethernet and fibre channel numbers, given the 100% growth those businesses
realized in FY99.
We believe the December 1999 earnings call will also be upbeat. The company is
having a stellar quarter for design wins, and we expect the company to report
growing production shipments into Lucent's Wavestar platform. At the same time
the company is reaping the benefits of a strong new product cycle.
We note that the company's stock has under-performed its peers in recent
months, due in part to concerns with Lucent that we believe are overblown. We
believe this has created a buying opportunity, and are raising our opinion from
an Accumulate / Buy to a Buy / Buy.
(VTSS) The securities of the company are not listed but trade over-the-counter
in the United States. In the US, retail sales and/or distribution of this
report may be made only in states where these securities are exempt from
registration or have been qualified for sale. MLPF&S or its affiliates usually
make a market in the securities of this company.
Opinion Key (X-a-b-c): Investment Risk Rating(X): A - Low, B - Average, C -
Above Average, D - High. Appreciation Potential Rating (a: Int. Term - 0-12
mo.; b: Long Term - >1 yr.): 1 - Buy, 2 - Accumulate, 3 - Neutral, 4 - Reduce,
5 - Sell, 6 - No Rating. Income Rating(c): 7 - Same/Higher, 8 - Same/Lower, 9
- No Cash Dividend.
Copyright 1999 Merrill Lynch, Pierce, Fenner & Smith Incorporated (MLPF&S).
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