Here is the full text of J.P. Morgan's Friday report (the only thing that's bad is "erosion of credibility", come on Mory, prove 'em wrong!)
ASCEND COMM.: LOWERING EPS AND TARGET PRICE; KEEPING BUY
BASED ON VALUATION
09:49am EDT 12-Sep-97 J.P. Morgan Securities Inc. (RABIN, WILLIAM (1-212)
648-
September 12, 1997
J.P. MORGAN SECURITIES INC. - EQUITY RESEARCH
WILLIAM D. RABIN (1-212) 648-8894
Charles A. Willhoit (1-212) 648-7146
Ascend Communications (BUY)
LOWERING EPS AND TARGET PRICE; KEEPING BUY BASED ON
VALUATION
AND MARKET
POSITION
Earnings Per Share P/E
ASND 52-Wk ------------------ ------------ MkCap
9/11 Rge 12/96 12/97 12/98 3Q/97 3Q/96 12/97E 12/98E Yld ($MM)
---- ----- ----- ----- ----- ----- ----- ---- ---- ---- -----
$37.81 $36-80 $0.99A $1.25E $1.75E $0.29E $0.28A 30.2 21.6 -- 7,501
Previous $1.36E $1.98E $0.33E
We are reiterating our BUY recommendation on shares of ASND and
establishing a new target price of $55 (down from our previous target
price of $70). We are also establishing more conservative EPS projections
of $1.25 for 1997 and $1.75 for 1998, down from $1.36 and $1.98
respectively. While we believe that Ascend stands to gain from strong
demand in the carrier and ISP markets as well as from its excellent
product portfolio and leading market positions, the company is suffering
in the short term from a lack of visibility and an erosion of credibility.
We believe that demand in the carrier and ISP markets are strengthening as
these service providers prepare to expand existing network infrastructures
over the next 12 months. In our opinion, Ascend is very well positioned
to take advantage of this approaching buildout as the company has the four
major product lines that are needed in this market; frame relay switches,
ATM WAN switches, high speed routers, and, of course, remote access
concentrators. While we are optimistic about the company's 12-month
prospects, there continues to be a lack of near-term visibility and
several market factors, including fewer, but larger customers and
declining average selling prices (ASPs), are causing us to have a more
conservative financial outlook.
Table 1: Revised Revenue and EPS Projections
3Q/97E 4Q/97E 1997E 1Q/98E 2Q/98E 3Q/98E 4Q/98E 1998E
New Revenue $315.0 $337.1 $1,256.5 $374.1 $419.0 $456.7 $511.5 $1,761.4
Projections
New EPS $0.29 $0.34 $1.25 $0.38 $0.42 $0.45 $0.50 $1.75
Projections
Previous EPS $0.33 $0.42 $1.36 $0.43 $0.47 $0.52 $0.56 $1.98
Projections
Source: JPMS.
We are lowering our revenue and EPS projections for four primary
reasons:
As we stated last week, Ascend's current quarter will be very back-
end loaded with the end result hinging on the company's European remote
access business. Over the course of the last week, it is becoming
more evident that the company may not be able to close enough business to
meet our previous revenue estimate of $333 million. As such, we have
lowered our revenue estimate for the quarter to $315 million, a very
slight sequential increase from the second quarter.
Ascend is currently running a promotional program deemed the MAX
Value Program, admittedly aimed at helping the company generate revenue in
the last month of the quarter. The promotion runs from September 2 -
September 30, 1997, and basically allows customers to buy one MAX 4048
concentrator and get one free (the MAX 4048 is a lower-end concentrator
than the TNT which supports up to three 16 port cards in a 6-slot
chassis). If a customer buys three 4048s, they qualify to receive a free
TNT remote access concentrator as well. The program is aimed at smaller
ISPs located in the U.S. and Canada. While the promotion may have
some incremental effect on revenues in the third quarter (most successful
promotions generally run for at least 90 days), there is a risk that
revenue and margins will be slightly affected in the fourth quarter as a
result.
Sales cycles for Ascend appear to be lengthening and the results are
just beginning to be seen. Until recently, Ascend's customers were
small, nimble ISPs hungry for new, faster products. As such, Ascend would
generally deliver new products that were about 90% complete, making the
finishing 10% touches at the customer site. This afforded Ascend the
ability to bring products to market quickly and ramp up sales immediately.
We are now starting to see a change in the philosophy of a major portion
of Ascend's customer base. Its once smaller customer base has turned into
large ISPs and major telecom carriers, the result of a flurry of mergers
over the past year. Bell Atlantic/NYNEX, SBC/Pacific Bell,
WorldCom/UUNet, GTE/BBN - these are just some the examples of customers
that have dramatically grown in size. The net effect on Ascend is the
establishment of a customer base each with more buying power and higher
standards for product acceptance. This, inevitably, is lengthening
Ascend's sales cycles, thereby affecting visibility.
While price erosion has not been a major issue to date in the remote
access market, we believe that price/port figures may decline slightly
faster than we had originally predicted. The Dell'Oro Group's latest
projections reflect this belief as their projections have average selling
prices (ASPs) declining at nearly twice the rate of their 1996 market
projections. While we are a bit more optimistic about pricing, we do
believe that increasing port densities and increased customer purchasing
power will bring prices down faster than we had expected over the next
several years.
Valuation: In our opinion, we believe that shares of ASND are
attractively valued at current levels, even given the recent turbulence at
the company. ASND is trading at 21.6 times our revised 1998 EPS of $1.75,
well below its peer average of about 26.5 times and just above the S&P 500
1998 P/E of about 19 times. We continue to believe that Ascend can
grow earnings at or near 40% for the next several years and we believe
that there is certainly upside to our new estimates should the company
improve its recent lackluster execution. Our more conservative target
price of $55 is calculated by applying a 12-month forward P/E of 27 times
(our next 12-months EPS is $1.43) to our subsequent 12-months EPS estimate
of $2.05.
Current Quarter: The third quarter of 1997, scheduled to close at
the end of this month, has been hampered by a lack of orders for remote
access equipment in Europe. As we reported last week, the company has a
substantial amount of business to close in the last month of the quarter.
Unfortunately, the past week has seen little change in order intake
from Europe and as such the quarter is now under even more pressure.
Because of this lack of visibility, Ascend is unable to provide any
realistic guidance. We do believe that the company's frame relay and ATM
WAN switching business (acquired from Cascade) is doing quite well.
Initially, we projected that this business would grow at least 10%
sequentially and that backlog would continue to improve. We remain very
comfortable with these estimates, although we believe that Ascend may
recognize more than 10% growth in the quarter to help make up for weak
remote access sales.
The Remote Access Market
The latest Dell'Oro Group research suggests that sales in the high-end
remote access market is growing at nearly 35% annually from 1996 through
2000, even with a view of expedited ASP declines. Ascend remains the
market share leader with a consistent market share position of about 35%
to 37% over the last 4 quarters.
Table 2: High-end Remote Access Market Shares
Company 2Q/97 Market Share %
Ascend 36.5%
3Com (U.S. Robotics) 30.8%
Cisco 14.2%
Source: Dell'Oro Group, 1997
Note: JPMS coverage of the above: 3Com: (COMS/$49.06/MARKET
PERFORMER);
Cisco: (CSCO/$72.19/BUY).
The Frame Relay Market
The latest Vertical Systems research (just released last week) projects
that the carrier and ISP frame relay market will grow about 23% annually
from 1996 through 2000, and recent projections from several other industry
research groups project annual growth at nearly 30% annually. Ascend, via
its Cascade acquisition, should remain the leader in the carrier and ISP
frame relay market with a 24% share.
Table 3: Carrier and ISP Frame Relay Market Shares
Company Projected 1997 Market
Share %
Ascend 24%
Cisco 17%
Newbridge 14%
Alcatel 11%
Nortel 8%
Source: Vertical Systems Group, 1997.
Note: JPMS coverage of the above: Newbridge: (NN/$55.00/LongTerm Buy);
Nortel: (NT/$95.25/BUY).
The ATM WAN Market
The most recent Vertical Systems projections suggest that the carrier and
ISP ATM market will grow at about 55% annually through 2000. Ascend,
Newbridge, and Cisco are all expected to gain incremental share of the
market in 1997.
Table 4: Carrier and ISP ATM Market Shares
Company Projected 1997 Market
Share %
Newbridge 33%
Cisco 22%
Nortel 11%
Ascend 8%
Source: Vertical Systems Group, 1997. |
