MERRIL LYNCH REPORT-Fundamental Highlights:
· We believe the broadband wireless access
equipment market could exceed $3 billion by
2003. Netro is currently the only publicly
traded company that is solely focused on this
market.
· The company's AirStar product is currently
being trialled by approximately 25 operators
around the world, and the company is
pursuing opportunities with several new
customers.
· With an innovative product, strong partners,
and a solid management team, Netro should
be able to capture 20% of this market over
time.
Comment
United States
Telecommunications Equipment/Networking
13 September 1999
Michael E. Ching
Timothy P. Long
Netro Corp
Pure Play in Broadband Wireless Access ACCUMULATE
Long Term
BUY Reason for Report: Initial Opinion
Merrill Lynch & Co.
Global Securities Research & Economics Group
Global Fundamental Equity Research Department
RC#20125605
Netro Corp – 13 September 1999
2
Initial Opinion
Netro is an early leader in the emerging broadband
wireless access market. The company's AirStar product is
currently being trialled by approximately 25 operators
around the world, and the company is pursuing
opportunities with several new customers. With an
innovative product, strong partners, and a solid
management team, Netro is well positioned to benefit from
a market that we expect will exceed $3 billion in four
years.
Outlook
Netro is a technology leader and pioneer in the broadband
wireless access equipment market. The company has
integrated Time Division Multiple Access (TDMA),
Asynchronous Transfer Mode (ATM) and Quadrature
Amplitude Modulation (QAM) into a single product. The
combination of these three technologies allows service
operators to offer high speed integrated voice and data
services to business users on a cost-effective basis.
n Market Opportunity
The target customers for Netro are a new breed of service
operator, sometimes referred to as wireless CLECs
(Competitive Local Exchange Carriers). These operators
will use AirStar to offer service to business users with the
following characteristics:
· Broadband – high speed, nominally 1.5 million bits
per second (Mbps), which is about 24-times faster
than the current fastest analog modem technology, and
comparable to existing DSL (Digital Subscriber Line)
and cable modem technologies. AirStar also offers the
unique capability of allowing users to send data in
bursts up to 16 Mbps. These speeds are more typical
of a business user than a residential user;
· Access – defines the connection between the end user
(where a terminal with an average selling price of
about $5,000 is required) and the network (where a
hub that ranges between $50,000 and $150,000 is
needed). Access is widely perceived to be the next
bottleneck in delivering higher speeds for
communications. Currently, the access market
represents more than $8 billion a year in annual
equipment sales;
· Wireless – refers to over-the-air, terrestrial based,
radio technology. Competing technologies are cable,
copper wire, fiber or satellite. However, because of
the extensive construction usually associated with
copper and fiber-based systems, the time to install one
of these systems can be long. Wireless has been
viewed as a way to reduce the time-to-deploy.
One issue that has historically limited the growth in this
market is the licensing requirements that are generally
associated with radio technology. However, licenses to
operate broadband wireless networks have been recently
awarded in several countries in South America and
Europe. It is for this reason that the first versions of
AirStar were designed to operate at 10 GHz and 26 GHz,
the two most common frequencies licensed in South
America and Europe, respectively.
In fact, international markets now represent nearly all of
Netro's revenues. One of four international customers
(NTL in the UK, Airtel in Spain, Techtel in Argentina and
Comsat in Peru) is likely to be the first to offer a broad
range of services using AirStar. (i.e., full network rollout).
In the U.S., wireless service is expected to be offered in
several frequency bands, including the MMDS
(Multichannel Multipoint Distribution Service) frequency
range. To obtain 200 MHz of spectrum in the 2.5 GHz
MMDS band, an operator would need to use the
Multichannel Distribution Service (MDS) and Instructional
Fixed Television Service (IFTS) channels. An MMDS
license alone can contain up to 100 MHz of bandwidth.
The Federal Communication Commission (FCC) has
licensed more bandwidth at higher frequencies. LMDS
(Local Multipoint Distribution Service), for example,
contains a 150 MHz and a 1.15 GHz channel transmitted at
a frequency of 28 GHz. Other operators own large chunks
of spectrum at higher frequencies including WinStar
(operating in the 38.6-40 GHz frequency band), Advanced
Radio Telecom (38 GHz), AT&T (through its acquisition
of Teleport/Biztel received a license at 38 GHz) and
NextLink (28 GHz). Because a larger amount of frequency
bandwidth was made available, higher speed
communications is possible. It is for this reason that we
believe that Netro's product has begun to target customers
with a broad spectrum license. In fact, Netro just recently
shipped its first 38 GHz product to a U.S. customer for
test, and will have a 28 GHz product by the end of 1999.
Over time, the U.S. market could represent 25% of sales.
n Partners
Netro has both direct and indirect sales efforts. Indirect
sales account for about 80% of the company's revenues.
The majority of the indirect sales are through two partners:
Lucent and Siemens. Netro is the Original Equipment
Manufacturer (OEM) for Lucent's OnDemand Access and
Siemens' SRA MP products.
Lucent has been responsible for bringing in customers
such as Airtel, Techtel, Comsat, and BroadNet in
Germany, while Siemens has delivered Retevision in
Spain, Sunrise in Switzerland and OTE in Greece.
While neither relationship is exclusive, we think the
technical superiority of AirStar gives Netro a substantial
competitive advantage that Lucent and Siemens will prove
difficult to find elsewhere. Also, the partnership between
these companies goes beyond just an OEM relationship.
Lucent and Siemens both currently own about 2% of
Netro, and Lucent helped jointly develop the 38 GHz
version of AirStar.
(Continued)
Netro Corp – 13 September 1999
3
n Solid Management Team
Gideon Ben-Efraim founded Netro in late 1994 after
starting P-COM in 1991. The rest of the senior
management team has extensive experience in
telecommunications and electronic components (CFO
Mike Everett joined from Raychem), systems integration
(CTO John Perry was previously at Nortel) and data
networking (Chairman Dick Moley and VP of Sales Matt
Powell both came from Cisco/Stratacom).
Issues
We believe the two biggest challenges for Netro will be to
effectively balance the unpredictability associated with the
emergence of a new market with the manufacturability of a
new product.
n Development of a New Market
The need for broadband access is being driven by demand
for Internet access, remote access to corporate intranets
and other data-intensive applications. But the lack of
available licenses and/or a cost-effective product has
hindered the growth of broadband wireless access, so we
have no reference point.
Frost and Sullivan, a market research firm, has analyzed
this nascent market, and estimates that broadband wireless
access equipment sales will grow at a compounded annual
growth rate of 70% over the next four years, exceeding $3
billion in 2003.
Over time, we expect the sales cycle to shorten
dramatically, and ultimately we believe we will see the
development of a large market opportunity. This view is
supported by Lucent and Siemens, as well as Nortel (using
products from BNI, which Nortel acquired in early 1998
for about $425 million), Motorola (whom along with Cisco
purchased SpectraPoint from Bosch Telecom) and Hughes
Network Systems.
n Contract Manufacturing
Currently, Netro has manufactured the majority of the
AirStar units sold from its facility in San Jose, California.
However, Netro alone can only produce about 100
terminals per month, far below expected demand.
To offset the risk in ramping up the manufacturing of a
new product such as AirStar, Netro has been working with
two leading contract manufacturers. Solectron and MTI are
both expected to be able to produce several hundreds of
terminals per month by the end of 1999.
Financial Model
There are a lot of reasons to be optimistic about Netro's
financial model. Based on the technical superiority of
AirStar and the strength of its partners, we believe that
Netro should be able to capture at least 20% of the
broadband wireless access equipment market over time.
Based on the average size of a commercial network, a
single large network deployment could easily contribute
over $50 million in annual sales.
In developing our financial model, we have assumed that
Netro will gradually approach that 20% share over the next
four years. Early on, results will be more driven by
manufacturing capacity, especially given the
unpredictability in the rate at which the market will
materialize. We estimate Netro's revenues at $16.4 million
in 1999 and $63.7 million in 2000, which assumes 1,100
terminal sold in 1999 and 8,800 terminals sold in 2000. By
2003, we expect Netro to be able to produce over 200,000
terminals, resulting in revenues of over $500 million.
With the extensive use of contract manufacturers, we
believe that Netro can achieve gross margins of 45-50%.
Operating expenses should reach industry norms (15-17%
of revenues in SG&A and 14-16% in R&D). Based on
these parameters, we expect Netro to breakeven in late
2000 and to be profitable in 2001. Given our current view
of the market opportunities, we would then expect to see
earnings more than quadruple in 2002, and more than
double in 2003.
In the current market environment, many investors may
look at the growth opportunities and use a price to sales
multiple. Using calendar 2000 revenue estimates, Netro's
stock is line with other rapidly growing broadband access
equipment companies. |
