ARCHIVE
July 23, 1999
Is Redback the Next Cisco?
By Alec Appelbaum
DAY TRADERS are probably all too
familiar with Redback Networks
(RBAK), the networking-equipment stock
that rocketed over 400% above its May
IPO price and has not looked back since.
But the febrile confines of the New
Economy can make it tough for long-term
investors searching for the next Cisco
Systems (CSCO) or Microsoft (MSFT)
to buy and hold. Redback could be that
company -- and then again, it could fall
back into the shadows. The question is,
how do you begin to figure it all out?
Redback makes only one product but
that may be enough to vault the
company into the front ranks of
technology providers for high-speed
Internet access. Redback's little black
box, dubbed the SMS 1000, helps
Internet service providers deliver
high-speed access by breaking the network bottlenecks rapid hikes in consumer
demands can cause.
Redback is not, however, one of those companies trying to take on Cisco.
Redback's product sits in front of Cisco's or some other company's router, the
piece of equipment that functions as a sort of digital traffic cop at a phone
company's central office, and takes some of the data-processing burden off of
that crucial device. By helping the router do its job more efficiently, Redback's
box lets Internet service companies offer multiple snazzy packages such as
video conferencing and software downloads without worrying about their
installed equipment conking out. "Service providers found that once the router
got to a couple hundred subscriber connections, it rolled over and died," attests
Redback CEO Dennis Barsema.
The product has gotten rave reviews, and the stock has performed dramatically
enough to show up on a screen we did for telecom-equipment screamers. On
Thursday it reported a 71% sequential growth in quarterly revenue, announced
20 new customers for a total of 95, and split its stock. But its biggest adventure
lies ahead.
First will come the inevitable competition from Cisco and others who want in on
the action. Cisco already has a similar network-management product, though
analysts say Redback's is far superior right now. But much will depend on how
Redback balances itself between the two warring camps in the battle over the
technology used for high-speed Internet access. Phone companies, in alliances
with Internet service companies such as America Online (AOL), are hooking up
huge modem banks to their wires for an approach known as digital subscriber
line (DSL). Cable companies, led by AT&T (T) and its not-quite house brand
Excite At Home (ATHM), are using cable modems to juice up the Internet over
cable lines.
The methods are comparable in speed and pricing. But in homes, cable
modems are likely to be twice as popular with consumers in 2002 (in part for
having gotten an earlier start). Now, 85% of Redback's sales have been to the
DSL camp. And DSL is a fine business, with projected growth rates in the triple
digits over four years. But Redback says cable companies will soon need its
solution. If that's true, Redback could be the company that supplies the
weapons to both sides -- and becomes the rare stock that keeps up with its
early price over several quarters.
Barsema acknowledges that of 20 million high-speed subscribers in 2002, 12
million are likely to use cable modems -- though he says "all those projections
go out the window" when AOL deploys DSL service, in conjunction with Bell
Atlantic (BEL) and SBC Communications (SBC), this fall. He diplomatically
declines to speculate on whether AOL will get its coveted access to the cable
networks.
But Redback's box is actually at the heart of the
war -- and that's where things get nasty. Just like
AOL wants to be able to offer its service over cable,
phone companies want the cable companies to
have to share their wires. GTE (GTE) used the
Redback box for a demonstration in Florida last
month to show how easy it was for cable companies
to open their high-speed networks to other service
companies. Excite At Home tried to brush aside the
demo, saying it skirted issues of sucked-out
bandwidth that would come up in a real-life
deployment. Those issues, it said, would only get
solved in equipment changes that comply with
standards set by the cable industry.
Even though Redback wants a big piece of the cable action, it's no fluke that it
went from zero revenue in 1996 to $9.8 million in revenue last year without
significant cable sales. "We focused on DSL back in '96 because it was in its
infancy and we were able to influence the architecture of its rollout," says
Barsema. That makes for good timing: Ryan Hankin Kent analyst Claude
Romans, who studies DSL, notes that the headaches of converting old phone
lines into Internet channels make phone companies desperate for a simple
troubleshooter. "You have multiple operators and multiple technologies, so it's
all played into a good thing for Redback."
Cable companies, in some sense, have less to get used to, because cable's
broadcast mechanics send one signal to lots of places at once. Thus,
cable-modem suppliers incorporate some network-management software into
their central equipment. But now, cable-modem vendors are facing situations
where a few users hog too much space on the cable lines with complicated
programs, resulting in slowdowns for other users. Excite At Home even capped
the amount of bytes its Bay Area users could download last month, provoking
much consternation among the locals. Barsema says that's Redback's cue.
Even though Barsema insists his goods can manage cable subscribers perfectly
well, two cable insiders say Redback's proven expertise falls short. "Setup tends
to be a little more customized in the cable environment," says Mark Komenecky,
vice president of marketing for a new startup called Broadband Access Systems
that is trying to make all-inclusive platforms for cable-modem service. Moreover,
it's not clear that the broadcast format that cable-modem vendors use requires
a network-management tool like Redback's. Michael Harris, who runs a research
firm called Kinetic Strategies, says cable firms are hankering to reduce the
number of boxes in their networks.
But that tune may change when cable companies start using the Internet to
carry phone calls digitally over cable wires. Ryan Hankin Kent's Tracy Vanick
notes that the engineers at the cable offices aren't always versed in delivering
voice calls, a more fluid and chancy process than sending movies to a TV.
Cable guys "would welcome some kind of easy [way of sending different
packages to different customers]," she says. And "Redback has made
something very easy for an unskilled operator."
Barsema hedges his bets. Asked to rattle off his key goals for the next year, he
lists "getting AOL to flip some percentage of dial traffic over to DSL" and
"continuing to work with RoadRunner and At Home and getting a couple of
strategic wins." (RoadRunner is the cable-modem service sponsored by Time
Warner (TWX), the nation's second-largest cable vendor; spokeswoman Sandy
Colony says she doesn't know of any discussions underway with Redback.) He
points out that a handful of overseas customers use its box for cable systems,
and says home-grown Internet provider EarthLink Network (ELNK) uses it to
manage cable and DSL traffic. "We have had good success in cable up to this
point, but we're looking for great success," he says.
The Street is playing the stock's momentum. Brean Murray, the only brokerage
that submitted a First Call report on the stock but didn't underwrite its IPO,
raised its target price to $195 two weeks ago, based on an estimated 40 times
2000 revenue and its "good positioning" in cable contexts. Barsema must know
that he can't satiate such expectations without a cable revenue stream, even as
he insists that he doesn't worry about the stock price and doesn't try to justify it.
"The only thing we have control over is the results we report to Wall Street," he
says.
But as Wall Street gets used to triple-digit returns, those results may have to get
more and more ambitious. And Cisco's new network-management box means
that Redback's DSL stronghold isn't as impregnable as it seemed. Barsema,
who jokingly congratulated himself for getting through 35 minutes of Thursday's
call without mentioning Cisco by name, points to his "80% market share" as a
security blanket, but sell-side analysts are already talking up a takeover story.
Barsema insists he is pleasantly surprised by it all. The overall market "has
exceeded my wildest expectations," he says. "There are still issues, but I know
the plans that the largest service providers in the world have and it's
accelerating at a pace exceeding our projections."
The next year, and the next chapter in the cable-access saga, will largely
determine what kind of stock Redback becomes. If it remains a provider for the
DSL hordes, the stock should settle at some comprehensible (and decidedly
lower) price. But if Redback manages to roll into the cable world, this IPO
poster-child may be one for the ages.
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