FOOL ON THE HILL
An Investment Opinion by Randy Befumo
The Descent of Ascend
Uncertainty about when a 56 kilobit-per-second modem standard will be finalized combined with weak sales in the month of
July has sent shares of ASCEND COMMUNICATIONS (Nasdaq:ASND) into a tailspin. Although the nominal cause of
today's $2 1/2 decline to $41 3/8 is an about-face on the part of a Merrill Lynch analyst, the news is another regurgitation of
the concern about July sales first seen when Ascend published its 8-K filing. With Monday's Network World revealing that the
basic intellectual property for 56K modems may actually be in the hands of a foreign national and not any of the companies
currently involved in the standards setting process, there is even more concern now that Ascend's sales over the next few
months could be slower than expected.
Ascend revealed on August 11 that "[f]or the 31-day period ended July 31, 1997, Ascend Communications, Inc., a Delaware
corporation, had consolidated net income of approximately $2.9 million and consolidated sales of approximately $62.8
million." With Ascend having 188.4 million shares outstanding as of its last quarterly filing, this implies that Ascend only made
one and a half cents per share in the first month of the third quarter, leaving thirty-three and a half cents per share to go if it is
going to meet current analyst earnings estimates. Although Ascend's quarters are typically "back-end loaded," meaning that it
does most of its business in the final weeks of the quarter, investors have been increasingly unwilling to tolerate any uncertainity
from networking-related companies after the entire group got mashed last April.
Investors may be right to worry. With Ascend's net sales for the second quarter at $311.7 million, the company's July sales
only approximate 20% of last quarter's earnings. To match expectations of sequential sales growth, the company will have to
more than double July sales in August and September. Ascend has historically done a huge hunk of business in the closing days
of the quarter, but it has not done so with business at the company's new Cascade unit in the dumper and the continuing
squabble over 56K technology. Monday's Network World bombshell indicating a 56K standard may take more than a year
to materialize only further erodes confidence.
While there has been a mass proliferation of wide-area network (WAN) technology to allow for remote access and expand
the public network called the Internet, many providers have been waiting for the international standards committee to come up
with one 56K standard before fully deploying the technology. However, a relative unknown in technology circles named Brent
Townshend now claims to have a broad patent filing on basic 56K pulse code modulation modem technology. A committee
member for Inter-national Telecommunication Union (ITU) has contacted Townshend and reported that he seems open to
licensing his patent, but the modem-gear manufacturers may prefer to take this to court rather than paying what could be
hundreds of millions of dollars in royalties based on the patent.
Originally the ITU had planned on formalizing the modem standard in September, the last step before it would be finalized in
January. With one formal standard, many companies reliant on wide-area technology would have felt comfortable buying either
Ascend or U.S. Robotics/3Com remote access gear knowing that it would all be interoperable. Now those same people are
expressing some concern over mass deployment of one standard when the standard could change, leaving Ascend in a bind
because of its decision to license the Rockwell/Lucent 56K technology over the U.S. Robotics/3Com technology. Even if
Townshend agrees to license his patent, it is unlikely that the major modem manufacturers will let the patent stand without a
fight. Les Brown, chairman of the ITU committee, still hopes a 56K modem standard agreement can be reached next month,
but investors are discounting shares of Ascend as they perceive that the inherent risk as rising.
With $311.7 million in sales last quarter, Ascend's annualized revenues are approximately $1.3 billion. With the stock currently
at $41 3/8, the company is capitalized at $7.8 billion less $562.1 million worth of cash on the balance sheet, or 5.8 times
annualized revenues. The company is trading at 33.4 times its annualized earnings from last quarter (netting out charges for the
merger with Cascade Communications), but the valuation really only holds up if Ascend can generate the kind of growth that
its current earnings estimates call for.
As it stands, Ascend will only increase earnings by 16% to $0.36 per share if it makes its quarterly estimates, although this
would also be a 16% sequential improvement (including the weak Cascade results). This is certainly possible if Cascade's
business has improved as advertised, but if the standards shuffle puts any pressure on sales, the company could easily fall a few
pennies short of the estimate and see its P/E multiple continue to shrink. Even trading in the low $40s, the shares require a time
horizon of longer than a year and a tolerance for volatility. |
