HMQT: 1 of 2 Momentum Continues to Build. Raising Price Target to $60. Add to F
(First Call 11/22 08:11:23)
08:10am EST 22-Nov-99 Hambrecht & Quist (Matt Belkin) WIND INTS LU MSFT LBRT
**** Hambrecht & Quist **** Hambrecht & Quist **** Hambrecht & Quist ****
Company: Wind River Systems
Price: 32
Recommendation: Buy - Focus List
Notes: a, b,f
Analyst: Matt Belkin 415-439-3585
Date: 11/22/99
1 of 2 Momentum Continues to Build. Raising Price Target to $60. Add to
Focus List.
* Wind reported a strong Q3. Revenues of $44.6 mil easily beat our $41.9 mil
estimate.
* Earnings were in line with our 17" expectation as Wind continues to invest
in the post-PC opportunity.
* Wind continues to gain momentum in the embedded market, as evidenced by
several strategic agreements announced during the quarter including Intel and
Lucent. We expect more in the near-future.
* While all embedded players stand before a substantial opportunity relative
to the massive consumer appliance and Internet infrastructure build-out, Wind
is without a doubt our "must-own" favorite.
* We are raising our price target to $60 and adding Wind to our Focus List.
*
1999 A 2000 E 2001 E
Q1 EPS $0.10 $0.10a $
Q2 EPS 0.13 0.14a
Q3 EPS 0.16 0.17a
Q4 EPS 0.19 0.20
FY EPS 0.58 0.61 0.75
FY REVS (M) 131.9 166.7 205.0
CY EPS 0.61 0.75 --
CY P/E 57 46 --
FY Ends Jan Current Price $32
52-Week Range $11-35 Market Cap (M) $1539.6
Shares Out (M) 43.99 Book Value $3.99
Net Cash/Share $1.68 3-Year EPS Growth 35%
Summary Wind reported strong third quarter results, easily surpassing
our $41.9 million revenue estimates with sales of $44.6 million. We find this
number particularly impressive given the moderate transition risk inherent to
this quarter (i.e. new CEO, announced acquisition of ISI, launch of TMSv2,
etc.). Earnings of 17" met our estimate as we expected and will continue to
expect over the next several quarters as Wind reinvests in product development
and infrastructure expansion. Though long a fragmented opportunity, the
embedded market has begun to coalesce rapidly over the past 12 months, driven
by a massive surge in demand for Internet infrastructure and consumer Internet
appliance technology. As a proxy, aggregate growth in these two "verticals"
is outpacing overall industry growth by at least a factor of two. While many
players will indeed reap the rewards of this opportunity, Wind River is
without a doubt our favorite given the company's broad product portfolio,
global sales presence and strengthening list of top-tier partners - including
Intel, Lucent, and Liberate - just to name a few. While the stock has had a
nice run, we believe we have had only a small taste of what is to come. Given
the sheer size and scope of the market opportunity and Wind's dominant
positioning, we are raising our price target to $60 and adding Wind to our
Focus List.
Leading the Charge into the Post-PC era Wind's momentum continued to
build through the third quarter as was evidenced in part by a reaccleration in
sales to the 30% level, from an average of 25% in the first half of the year.
Wind also announced Intel and Lucent as strategic partners in the quarter, and
we expect many more on the way. We believe relationships such as these will
prove to be a vital differentiator for winners in the embedded market as we
enter the post-PC era. Broadly defined, the post-PC opportunity relates to
the massive built-out of Internet infrastructure (i.e. routers, switches,
servers, SANs, intelligent RAID) and consumer-oriented Internet devices (i.e.
smart phones, PDAs, set-top boxes, digital cameras) currently underway. All of
these devices contain embedded intelligence, at the heart of which lies an
embedded system. Though historically this consisted of a mere RTOS,
increasingly embedded suppliers must provide an integrated solution, complete
with graphical user interfaces, in some cases Java, networking protocols, and
focused component libraries. With a growing arsenal of embedded IP, we
believe Wind continues to distance itself from the competition. Below we have
listed just a brief summation of many of these products --
Table 1 - Sampling of Wind's Solutions
Product Announced First Shipment
Tornado for I2O February 1996 October 1997
Tornado for Embedded Internet June 1997 Third Quarter 1997
Tornado for Java July 1997 March 1998
Tornado for DSP September 1997 Fourth Quarter 1997
Tornado for PersonalJava March 1998 Second Quarter 1998
Tornado for Digita April 1998 April 1998
Tornado for TrueFFS July 1998 July 1998
Tornado for Automotive Control February 1999 February 1999
Tornado for Managed Switches October 1998 Second Quarter 1999
The pending acquisition of ISI will only further strengthen Wind's portfolio
of IP in our opinion, adding strength in automotive and consumer, as well as
design services. While indeed the opportunity is still an emerging one and
several far more capitalized competitors lurk about (i.e. Microsoft, 3Com,
Sun, among others), we believe Wind has the right raw materials to emerge as a
dominant force in the embedded market.
Center of Excellence a Strong Differentiator Further distancing itself
from the competition, Wind created a Center of Excellence during the quarter
aimed at nurturing relations between Wind and silicon vendors. In effect,
Wind will dedicate a handful of engineers (at the silicon vendors expense) to
perform on-site ports to future microprocessors. In doing so, silicon vendors
eliminate much of the lag between the release of new silicon and a customer's
ability to design applications for the new platform. In turn, Wind gains a
significant competitive advantage by being first-to-market with OS support for
next-generation silicon. Though the initiative is new and highly innovative,
Wind has already signed up Intel as the first participant and we will look for
more over the coming months.
VAR Channel Continues to Strengthen Best known for the collaboration
with Intel on I2O, Wind's VAR channel continued to strengthen in the quarter,
with Lucent announced just a few weeks ago. In addition, Liberate, another
significant VAR, announced that Cable and Wireless had opted to move forward
in the first phase of set-top box deployment. This deployment is not only a
significant validation of Liberate's technology, but more broadly, strong
evidence that the post-PC age is indeed upon us. One of the biggest moving
targets in the embedded market (as was the case with I2O) is predicating when
(and if) royalties ramp. This is particularly the case in the consumer market
where many home-run design wins amount to virtually zero in terms of royalties
as consumers never embrace the technology. We believe this is changing.
Liberate Relationship Gaining Traction As with all VAR relationships,
Wind receives an undisclosed royalty on each unit shipped. Taking the
Liberate example, given Liberate's current carriers, there are 160 million
potential set-top box subscribers. Though it is not exclusive, Wind provides
the only reference platform thus far for Liberate's set-top box technology and
hence, receives a royalty on each set-top box (Wind-enabled) that is deployed.
Simply put, Wind stands before a massive royalty opportunity - one that we
believe is largely unrecognized by Wall Street.
Pairing up with Lucent for Internet Telephony Similarly, the Lucent
phone-on-a-chip initiative announced just a few weeks ago exposes Wind to
another substantial royalty opportunity. Though it is difficult to size the
market for system-on-a-chip (SOC) Internet telephony solutions, Lucent is the
#1 communications chip supplier in the world. According to the company,
Lucent's SOC business alone totals $1.8 billion in sales annually. Under the
terms of the agreement, Wind receives a royalty on each Wind-enabled chipset
sold. We expect royalties from this relationship will begin to show up in the
second half of fiscal 2001.
Finally, I2O, perhaps the longest standing VAR agreement for Wind (with Intel)
has begun to gain significant traction in the marketplace. On the conference
call, management noted I2O royalties alone were $1.3 million, up over 400%
from the prior year. While we do not expect this year over year growth to
continue, we see I2O as another significant royalties opportunity as the
technology is embraced over the next several years.
1999 Copyright Hambrecht & Quist LLC. All rights reserved. The information
contained herein is based on sources believed to be reliable but is neither
all-inclusive nor guaranteed by our firm. Opinions reflect our judgment at
this time and are subject to change. We do not undertake to advise you of
changes in our opinion or information. In the course of our regular business,
we may be long or short in the securities mentioned and may make purchases
and/or sales of them from time to time in the open market, as a market maker,
or otherwise. In addition, we may perform or seek to perform investment
banking services for the issuers of these securities. Most of the companies
we follow are emerging and mid-size growth companies whose securities
typically involve a higher degree of risk and more volatility than the
securities of more established companies. For these and other reasons, the
investments discussed or recommended in this report may be unsuitable for
investors depending on their specific investment objectives and financial
position. This report is not a recommendation or a solicitation that any
particular investor should purchase or sell any particular security in any
amount, or at all. For additional information on the securities mentioned or
on suitability considerations, please contact your account executive.
RESEARCH NOTES: H&Q publishes brief Research Notes covering very recent or
developing events or situations regarding companies or industries covered.
These reports are made available to interested clients of H&Q on a request
basis. They often contain only partial information in very brief, often in
outline form; their purpose is to provide rapid information and preliminary
evaluations of such events or situations which may very rapidly be changed as
a result of subsequent additional information and analysis. Please contact
your account executive for additional detail.
Note Legend:
(a) Hambrecht & Quist LLC maintains a market in these stocks.
(b) Hambrecht & Quist LLC has been an underwriting manager, or co-manager, or
has privately placed securities of these companies within the last three years.
(c) Hambrecht & Quist LLC has an investment position in these companies.
(d) A Hambrecht & Quist LLC employee is a director of these firms.
(e) The analysts covering these stocks have investment position.
(f) Options are available on these issues.
(g) Entities associated with Hambrecht & Quist LLC have an aggregate
beneficial ownership of more than 5% of the outstanding equity securities of
these companies.
(h) Hambrecht & Quist acts as a financial advisor to this company.
(r) Restricted. No recommendation at this time. May, but does not
necessarily, designate company in registration.
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HMQT: 2 of 2 Momentum Continues to Build. Raising Price Target to $60. Add to F
(First Call 11/22 08:11:23)
08:10am EST 22-Nov-99 Hambrecht & Quist (Matt Belkin) WIND INTS LU MSFT LBRT
**** Hambrecht & Quist **** Hambrecht & Quist **** Hambrecht & Quist ****
Company: Wind River Systems
Price: 32
Recommendation: Buy - Focus List
Notes: a, b,f
Analyst: Matt Belkin 415-439-3585
Date: 11/22/99
Further down the line, and perhaps even lesser known to the investors, is the
potential for Wind to become a development platform as devices such as
Internet telephones begin to attract application developers. This evolution
would not only drive incremental sales of Wind's development environment
(tools) but more importantly, the broad proliferation of Wind's IP for which
Wind will again receive a royalty. Though tantalizing, we suspect this
evolution is at least a few years out.
Overall, we believe both Wind's increasing critical mass and announced
intention to acquire ISI are driving many of these relationships as vendors
seek to partner with the undisputed market leader. We will look for more of
these agreements over the coming months as further evidence of Wind's
strengthening market position and as catalysts for revenue acceleration.
Acquisition of ISI Expected to Close Early 2000 Management expects the
acquisition of ISI to close late January or early February 2000. Though we
will not publish pro-forma estimates until the acquisition closes, Wind is due
to file a preliminary proxy in the next few days at which point we will
publish informal estimates. Because ISI is a February fiscal year, Wind must
wait until mid-December until the November quarter 10-Q is filed and Wind can
submit the final proxy for shareholder approval. In the meantime, HSR expires
December 3.
Raising Revenue Estimates, Target Price to $60 Given the strengthening
outlook for Wind, we are raising our revenue estimate for fiscal 2001 to $205
million from $190 million. We are also raising our target price to $60, or
13x our new revenue estimate. Though ultimately earnings will be the best
metric by which to value Wind, given Wind's current period of reinvestment we
believe sales expansion is the more appropriate measure over the next fiscal
year.
1999 Copyright Hambrecht & Quist LLC. All rights reserved. The information
contained herein is based on sources believed to be reliable but is neither
all-inclusive nor guaranteed by our firm. Opinions reflect our judgment at
this time and are subject to change. We do not undertake to advise you of
changes in our opinion or information. In the course of our regular business,
we may be long or short in the securities mentioned and may make purchases
and/or sales of them from time to time in the open market, as a market maker,
or otherwise. In addition, we may perform or seek to perform investment
banking services for the issuers of these securities. Most of the companies
we follow are emerging and mid-size growth companies whose securities
typically involve a higher degree of risk and more volatility than the
securities of more established companies. For these and other reasons, the
investments discussed or recommended in this report may be unsuitable for
investors depending on their specific investment objectives and financial
position. This report is not a recommendation or a solicitation that any
particular investor should purchase or sell any particular security in any
amount, or at all. For additional information on the securities mentioned or
on suitability considerations, please contact your account executive.
RESEARCH NOTES: H&Q publishes brief Research Notes covering very recent or
developing events or situations regarding companies or industries covered.
These reports are made available to interested clients of H&Q on a request
basis. They often contain only partial information in very brief, often in
outline form; their purpose is to provide rapid information and preliminary
evaluations of such events or situations which may very rapidly be changed as
a result of subsequent additional information and analysis. Please contact
your account executive for additional detail.
Note Legend:
(a) Hambrecht & Quist LLC maintains a market in these stocks.
(b) Hambrecht & Quist LLC has been an underwriting manager, or co-manager, or
has privately placed securities of these companies within the last three years.
(c) Hambrecht & Quist LLC has an investment position in these companies.
(d) A Hambrecht & Quist LLC employee is a director of these firms.
(e) The analysts covering these stocks have investment position.
(f) Options are available on these issues.
(g) Entities associated with Hambrecht & Quist LLC have an aggregate
beneficial ownership of more than 5% of the outstanding equity securities of
these companies.
(h) Hambrecht & Quist acts as a financial advisor to this company.
(r) Restricted. No recommendation at this time. May, but does not
necessarily, designate company in registration.
First Call Corporation, a Thomson Financial company.
All rights reserved. 888.558.2500
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