Some BRCD among others.
5 Net stocks worth holding for 5 years
You know the big names, like Cisco Systems and JDS Uniphase. Here are five more you should consider: Brocade Communications Systems, PMC-Sierra, Juniper Networks, ARM Holdings and UnitedGlobalCom.
By Michael Brush
Set out to select five leading Internet stocks to hold for the next five years, and one thing becomes clear right away: There is an embarrassment of riches. To narrow the field, our first step was to eliminate the obvious plays. By now, who hasn't heard about Cisco Systems (CSCO, news, msgs), JDS Uniphase (JDSU, news, msgs), EMC Corp. (EMC, news, msgs) and Oracle (ORCL, news, msgs)? If those companies aren't in your core tech portfolio already, maybe we can't help you anyway.
At the same time, we had to cut potentially big winners like cable-equipment maker Terayon Communication Systems (TERN, news, msgs) or fiber-optic switch and software manufacturer Sycamore Networks (SCMR, news, msgs). While many companies like these have promising approaches to solving some problems with the Internet, it's not clear at this point that their solutions will one day become the standard.
Instead, we looked for five companies that are solidly positioned in front of some trend that will support a five- or 10-year spending cycle. Next, we wanted the leaders in their field: companies with the best technology or decent barriers to entry around their business, strong management and good earnings revisions. Here are five companies that appear to fit the bill.
Brocade Communications Systems
As e-commerce heats up and broadband gets more use, companies will need better ways to store all the data they're creating. Two major breakthroughs in the past few years will help a lot; both lay the foundations for the next generation of storage systems to be used by businesses. Brocade Communications (BRCD, news, msgs), as a major supplier of the building blocks for these systems, is well positioned to benefit from this trend.
The first breakthrough was fibre channel, a faster, more reliable protocol for letting computers and servers talk with other devices like storage drives. The second was the storage area network, or SAN. This is a separate, dedicated network for storage that offers systems managers a lot more flexibility. "Switched fabric" SANs, for example, can support more than a million devices in an "any-to-any" configuration. This means lots of different servers can access storage at once without causing any disruptions, which is useful if you're running an e-commerce site.
Analysts reckon we are at the start of a 10-year spending cycle for fibre channel and SAN. This is good news for Brocade, since its SilkWorm family of fibre-channel switches is used in about 80% of the fibre-switch market. Brocade has an advantage over potential competitors because it has locked up close relationships with SAN component makers like Dell Computer (DELL, news, msgs), IBM (IBM, news, msgs) and Compaq Computer (CPQ, news, msgs). This gives Brocade an advance look at their design needs -- and a chance to propose solutions before potential competitors even know what the problems are.
PMC-Sierra
This British Columbia-based company is one of the blue-chip providers of semiconductors used in the key building blocks for broadband. Its chip designs go into Internet infrastructure components like high-speed routers and switches sold by telecom equipment makers like Cisco Systems and Nortel Networks (NT, news, msgs). They in turn sell to companies building out broadband, such as AT&T (T, news, msgs) and MCI WorldCom (WCOM, news, msgs).
PMC-Sierra (PMCS, news, msgs) has focused on products used in slower-speed connections found at the "edge" of the network. In this case, slow ain't bad. In fact, this is where growth is the hottest. (The company also is developing products for much higher network speeds.)
PMC-Sierra has a great record when it comes to chalking up design wins. This augurs well for long-term earnings, given the lengthy life cycle of its products. About half of the company's revenue last quarter came from products introduced before 1996.
The company also does a good job of locking up intellectual property, or design smarts. It does this both through acquisition and by working closely with the equipment makers. "By aligning themselves tightly with their customers, they are able to put more silicon in each box, with each generation," says Peter Conrad, an analyst with Kopp Investment Advisors in Minnesota.
Another trend that helps here is outsourcing. Equipment suppliers once had the time to develop their tech in-house. Now as carriers compete to build out broadband, there is no time for that. That means more functionality gets farmed out to companies like PMC-Sierra, assuring they will grow even faster than the equipment makers they supply.
Juniper Networks
As old-style electronic-network routers continue to create more bottlenecks because optical networks require faster speeds, you can expect the networking giant Cisco Systems to continue to lose ground to a relative newcomer: Juniper Networks (JNPR, news, msgs).
The Mountain View, Calif.-based company's flagship product, a high-end gigabit router known as the M40, delivers at least 10 times the performance of other routers. That helps explain why Juniper has been aggressively stealing market share away from Cisco.
Juniper counts MCI WorldCom, Qwest Communications (Q, news, msgs) and Cable and Wireless (CWP, news, msgs) among its customers, which are three of the main Internet-backbone carriers which together move 75% of Net traffic. Juniper also sells to nine of the top 10 Internet service providers. It now has 18% of the core router market.
"It is a startup vs. an incumbent, where the incumbent has an installed base to protect," says Jae Lee, a technology analyst with American Express Financial Advisors. "For that reason, Cisco has not been all that successful in getting new products out the door. Juniper is a collection of former Cisco guys who understand the technology and are good at getting product out. Juniper has the best product out there."
Formidable Cisco remains a threat, but other contenders will have a hard time breaking in. While Juniper has designed high-speed routers that operate with Cisco's networking software, this is no easy task. Besides, buyers like to have a second supplier (Juniper), but three tends to be a crowd. It makes things like testing, support and logistics too expensive.
ARM Holdings
At some point soon, Web surfers will get on the Internet through third-generation (3G) wireless phones and those Internet appliances you keep hearing about. One of the best ways to invest ahead of this trend is through ARM Holdings (ARMHY, news, msgs), says Mark Anderson, publisher of Strategic News Service. The United Kingdom-based company designs much of the chip technology that will be used in these devices. "ARM has a big chunk of the market and it is growing at fantastic rates."
The company designs microprocessors that are in high demand because they are fast, cheap and easy on the batteries in those hand-held devices. Then it licenses that technology to chip producers like Texas Instruments (TXN, news, msgs), Intel (INTC, news, msgs), Cirrus Logic (CRUS, news, msgs) and Atmel (ATML, news, msgs). Chips based on ARM technology are so hot that they help run about two-thirds of all handsets sold last quarter. They are in virtually all Nokia (NOK, news, msgs) cell phones. (ARM collects a small royalty on each phone.) While the lion's share of ARM's revenue comes from portable phones, its technology also shows up in "embedded chips" used in things like fax machines, modems, printers, digital cameras and set-top boxes.
Aside from the 3G handsets, another source of growth ahead will be Bluetooth. This emerging radio-link technology allows devices to talk with each other over distances of up to 30 feet. It will be used one day to do things like substitute radio links for that cable spaghetti behind your computer, or connect wireless headsets to a portable phone in your pocket.
UnitedGlobalCom
Cable access to broadband promises to be one of the hottest areas of Internet growth. Few companies offer the kind of exposure you can get from UnitedGlobalCom (UCOMA, news, msgs), a Denver, Colo.-based firm that owns cable assets around the globe.
Its biggest presence is in Europe, where it connects about 12.5 million homes. But the company also has extensive cable systems in Australia and New Zealand, and a growing footprint in Latin America. "No one has collected a more-attractive arsenal of networks around the world," says Eric Semler of Georgica Advisors, a New York-based money management firm that has a position in the company. Like AT&T, UnitedGlobalCom hopes to begin reaping benefits by selling telephone and Internet services (called chello) through the cable pipelines.
Despite this promise, UnitedGlobalCom shares look undervalued. To see why, first take the value of the shares it owns in its European subholding, the Amsterdam-based United Pan-European Communications (UPCOY, news, msgs), known as UPC. Then add the value of its stake in its Australian subholding, which trades in that country. Next, throw in the Latin American properties. The result: On this basis alone, UnitedGlobalCom should be trading at about $105 instead of the current $63, Semler says.
What might make the market wake up to this? Buy-side analysts who own the stock and Michael Fries, the company's president, think upcoming spinoffs will do the trick. They will help the market put a dollar value on hidden assets inside the company, driving up share prices. The road show for chello starts in a few weeks, Fries says.
By the end of the year, UPC should spin off UPC Media (European broadcasting) and Priority Telecom (European telecom). Some kind of Latin American subdivision should go public in that time frame, as well. In each case, UnitedGlobalCom will keep a controlling interest. But the spinoffs alone should tack on another $50 or $60 to the firm's share price, says Semler.
At the time of publication, Michael Brush owned or controlled shares of the following equities mentioned in this column: Brocade and PMC-Sierra.
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A little biased, but it makes me feel good after this week.
Jack |
