Craig and others:
Just my two cents regarding the ongoing valuation debate surrounding WIND and the other RTOS players.
While WIND appears to be highly valued on a relative basis, the opposite is in fact true. Some evidence to support this point:
1) While WIND is now trading at approxiamately a 55 PE, this is down from its historical range of about 80-100 trailing 12 month's earnings. So although 55 PE seems high, it is already considerably off from its historical range, and well beneath its intrinsic value. The most recent tech sell-off that began with the IBM crack and COMS poor earnings continues to spill over into all the high flying technology stocks. First it hit the networking companies with premium multiples, like SHVA, ASND, CSCO, and COMS, then extended into the core holdings like INTC, and now is finally touching even the most untouchable stock, MSFT. For whatever reason, the market seems to be punishing all premium multiple stocks the same, clipping the supposed high flyers like WIND along with all the other supposedly slower growth industries like networking and semiconductors.
2)WIND's multiple has come down, despite the fact that it has exceeded analyst's estimates for six consecutive quarters. Based on the considerable backlog that WIND is building, revenue growth of 45% and earnings growth of 75% (after adjustments for the increased shares) seems to be quite sustainable. WIND now enters the quarter with tremendous foward vision, being almost two-thirds of the way towards their earnings target for the next quarter as they close the previous quarter. The nature of the business, with the tremendous amount of royalty flows, allows for this type of foward vision.
3) As Allen has stated many times, trailing earnings are largely irrelevant when examining a company like WIND. While WIND recognizes the revenue from sales of TORNADO and training fees, constistuting the majority of their historical earnings, this only tells part of the story. Take the well-publicized INTEL deal as an example.
When WIND books the revenues from the INTEL deal, it recognizes the sale of TORNADO and the associated seat licenses, as well as any training revenue taken in for tutorials with TORNADO. For argument's sake, let's peg this number arround $100,000 (the value of one TORNADO tool kit, and multiple user licenses).
But as shareholders, we know that this is not the full value of the INTEL deal. It's the value of the TORNADO sale, plus the present value of the annuity that comes from all the sales of I960 processors. But this annuity is not recognized in historical earnings. Royalty checks are not recognized until they come in, making the value of the INTEL deal in both revenues and earnings. Extrapolate this out to each of the other 8500 design wins to date (Some one unit, some million unit deals), and you begin to get a picture of how understated trailing earnings are for a company like WIND.
4) Analyst estimates, which WIND has now beaten for the last six quarters, are by their own admission, understating WIND's possibilities. Most of the analysts that follow the stock (there are four: Wessels Arnold, Hambrecht and Quist, Deutsche Morgan Grenfell, and UBS) merely extrapolate a rate of growth for the RTOS industry and leave WIND's market share the same. This ignores the fact that the RTOS is growing faster than it has in the past as more engineering projects are outsourced. It also ignores the fact that WIND is INCREASING its market share as it becomes more established as the market leader.
What's more, none of the analyists that follow WIND have included either the I20 or Network Computer design wins into their forecast. As Allen has stated before, he believes that i20 has the potential to equal all other royalty streams put together. Clearly, any analyst projections that fail to include such a monumental deal are sure to continue to understate future earnings.
What does all this mean for WIND? Unfortunately, tech stocks are subject to tremendous correlation risk, as each successive tech sell-off makes abundantly clear. As more portfolio managers play in the tech sector, this correlation actually increases. A problem with networking stocks, due to a shakeout between COMS and INTC over network adapter cards, spills over into totally unrelated fields such as ROTS. This is one of the problems with the tech sector. And unfortunately, WIND will contine to suffer as long as the overall tech sector remains under pressure.
However, I am very confident that stocks ultimately trade to their intrinsic value. They have to. Which is what makes me so confident in WIND as an investment vehicle. It's intrinsic value is substantially greater than what it is currently worth, EVEN IF THEY NEVER SIGN ANOTHER DEAL. Of course, WIND signs new deals all the time, creating an even greater backlog of future royalty streams.
So, while the current market conditions are certainly distressing, they do nothing to destroy the underlying value of the company. Focus on the fundamentals, not the market's reaction to unrelated events.
Regards,
Jason Cogan |
