Pairgain news in Barrons!
Couple this with the some delayed purchasing from the FCC ruling on Thursday and we may have the catalyst that drives Pair into much higher territory. I think the FCC ruling will be digested by the institutions for the next couple of days and they we will begin to see a great focus on all xDSL companies.
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Weekday Trader
NEW YORK (Dow Jones)--1999 was the year cable modems emerged as the
high-speed access route of choice for Internet users (see Weekday Trader, "Excite
Deal Shows Cable Modem Is King," January 19).
Meanwhile the Regional Bell Operating Companies, or Baby Bells, dragged their feet
on a competing technology, Digital Subscriber Line (DSL), which bulks up existing
copper phone lines for broadband usage. (DSL is between six and 125 times as fast as
the current standard 56 KB modem, according to the Yankee Group.)
"The whole sector was stillborn," says Joel Achramowicz, an analyst at Preferred
Capital Markets.
But that's changing: Cable infrastructure upgrades are taking longer than many thought,
while renewed commitment by phone companies to high-speed access is helping DSL
turn things around. Thursday's ruling by the Federal Communications Commission
ordering local telephone companies to share their networks with competitors will also
accelerate the move to DSL.
"DSL is making a comeback," says Karuna Uppal, an analyst at the Yankee Group. Very
aggressive rollouts by the Regional Bell Operating Companies were unheard of six
months ago, she adds.
SBC Communications, for example, is spending $6 billion to blanket 80% of its region
with DSL access, and Bell Atlantic hopes to have 100,000 residential DSL subscribers
by the end of 1999.
"ADSL installations have really picked up the pace," says Steven Levy, an analyst at
Lehman Brothers. In fact, they could rise tenfold this year, to 500,000, from 50,000 in
1998, he says.
Cable modems definitely have a head start - 80% of homes with high-speed Internet
access have them, versus 20% with DSL lines - but DSL is catching up.
"We're seeing a lot more DSL shipments than we expected," says Cathie Hackler, an
analyst at San Jose-based Dataquest, a unit of the Gartner Group.
More importantly, the higher revenue stream DSL promises from business users, few
of whom have cable access, means DSL may have the last laugh.
"The business segment is going to lead the way to DSL," says Chandan Sarkar, an
analyst at the Soundview Technology Group.
One promising application called Voice Over DSL allows users to bypass local phone
companies while getting both high-speed Internet access and plain-old voice telephone
service through competitive local exchange carriers (CLECs). That can help businesses
cut their phone bills by 25% to 50%.
Today's FCC ruling will make the CLECs' efforts much easier and more affordable. By
sharing the Baby Bells' networks, they won't have to put in new lines, and could pass
those savings on to customers.
"This should speed up the whole process," says Achramowicz. "This pushes CLECs to
be more aggressive which should cause the RBOCs to be very aggressive as well."
That's good news for makers of DSL equipment, particularly those that make faster and
cheaper versions of DSL.
Those new, sexy flavors include G.Lite and HDSL2. G.Lite, which is used in homes, is
significant because installations can be done remotely, without the huge expense of
sending a truck to the home.
HDSL2, which is used in businesses, is twice as fast as the next-speediest form of DSL
and as much as 125x as fast as a 56K modem. Both will drive DSL adoption, says
Michael Pericka, an analyst at Olde Discount Corp.
"G.Lite could propel DSL to the mass market by bringing price points down, enabling
access to copper and the ability to compete on a price level with cable modems," he
says.
Who will benefit the most Pairgain Technologies has transitioned to providing HDSL2 from older T1 lines, which are about as fast but are at least three times morecostly than DSL.
Pericka, who rates the stock Accumulate with a price target of 19 (it closed Thursday
at 16 3/8), believes the shares are undervalued. "A lot of the upside in Pairgain lies with HDSL2,"
Pairgain, with a market capitalization of $1.1 billion, is nudging its 52-week high and
has an astronomical P/E of 149x estimated 2000 earnings of 11 cents a share. (It won't
make money this year.) But investors like Sarkar expect Pairgain's impending sale of
some of its less profitable units to unlock more value.
Levy also likes Orckit Communications (with a market capitalization of $475 million),
which he rates a Buy, with a price target of 40 (it closed Thursday at 26 13/16).
"They're the third largest vendor of DSL equipment in the world, behind Alcatel and
Cisco," he says. Orckit has 17% of the global market, according to Dataquest, and its
customers include Fujitsu, GTE and Deutsche Telecom.
Orckit's revenues from DSL more than doubled to $15 million in the third quarter of
1999, from $7 million in 1998.
"The market is just starting to take off," says Orckit president Izhak Tamir.
Orckit is 32% off its high of 38 7/16, and changes hands at a P/E of 15x expected
2001 earnings of $1.80, according to First Call. That's a nice discount to its projected
25% annual earnings growth rate.
Another favorite is Adtran, which has a market capitalization of $1.6 billion. Adtran
makes line cards (which hardware carriers install at their centers for high-speed
access) for lower-speed ADSL modems.
Levy considers Adtran undervalued. "The rest of the group sells at 10 times revenues,
and it sells at a discount," he says.
At 40 5/8, Adtran trades near its high and has a high P/E of 32x expected 1999 earnings
of $1.25 (though it's a discount to the group average of 70x 1999 earnings). But at 26x
the $1.56 it is expected to earn in 2000, the stock is only at a slight premium to its
projected 20% long-term annual earnings growth rate, and sells at a nice discount to its
five-year average P/E of 41x.
On the down side, competition is fierce, and DSL pure plays will be more exposed if
other, sexier technologies emerge. But cable modem suppliers have to grapple with
those issues, too.
"It's going to be an interesting horse race next year," says Achramowicz. "I wouldn't be
surprised if DSL makes up a lot of ground against the cable guys."
Investors are beginning to agree.
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