Tellabs May Be a Fallen Tech Angel ( Barron's on line )
By Carolyn Whelan
Some technology stocks aren't flying quite as high as they were at the end of
1999, even though the Nasdaq Composite Index is setting records every day.
One name on the bargain rack: Tellabs, which is still some 20% off its
52-week high. Illinois-based Tellabs makes switches and other equipment for
telecommunications carriers. (Lucent Technologies even resells Tellabs' Titan
gear under the Lucent name.) The company's cross-connect systems, which
disperse and route signals, are vital components of telecommunications
networks.
Until now, Tellabs has done particularly well in
vanilla-flavored voice communications, but has been
slower than some of its competitors (namely Nortel
Networks and Lucent) to move from circuit switching into next-generation
packet-based switching. (Packets are a faster, more economical way of
sending voice and data over networks.)
That's worried investors, as have shrinking sales from Sprint, a key customer.
(MCIWorldCom is acquiring Sprint, combining two of Tellabs' biggest
customers.)
The final straw? Last month the company cautioned investors it would report
disappointing earnings in its first quarter, which closes in March.
Altogether, Tellabs stock fell some 14% in one day.
"People got nervous when Tellabs said they [probably] won't meet or beat
expectations," explains Alex Cena, an analyst at Solomon Smith Barney, who
rates Tellabs a Buy and has a price target of 88 on the shares. (Late Monday
it traded at 61 1/2.)
Tellabs' accelerating research & development costs in the first half -- with no
related products expected to generate revenues until the second half --
"spooked people," he says.
But Cena and other bulls think investors overreacted: Research and new
acquisitions, they say, should pay off down the road. Most importantly, while
Tellabs ramps up its research, its bread-and-butter voice business -- a market
where revenues are expected to rise until 2003 -- is doing just fine, they say.
Indeed, voice remains today's "killer
app": More than 85% of
telecommunications carriers' revenues
still stem from voice services, including
Internet access, the key driver.
Fact is, most homes and small- to
medium-sized businesses (the
fastest-growing area of
telecommunications equipment sales)
still access the Internet through boring
old dial-up modems. Around 97% of
all Internet access worldwide is via dial-up, according to John Coons, an
industry analyst at San Jose-based Dataquest, a unit of the Gartner Group.
Sexier DSL and cable modems account for a measly 1% and 2% of that
market.
"It's going to be a while before the average Joe calls up Bell Atlantic [for]
high-speed Internet access," says Coons. "And we're not going to find DSL
and cable modems in hotels and condos for some time."
Meanwhile, there's lots of money to be made in voice. Total U.S. revenues
for transmission equipment (the area where Tellabs plays) are currently
expected to grow by roughly 50% to $12 billion in 2003, from $8 billion in
1998, according to Dataquest analyst Ken Kelly. And that may even be a
conservative estimate. "That's probably going to jump to $15 billion by then,"
he says.
Tellabs already is a player in the growing broadband market, through its call
control software, and it has established itself in the fiber optics area, a favorite
among fund managers. It also provides digital-based products to wireless
operators around the world, an explosive market.
Moreover, analysts applauded its purchase of SALIX Technologies in late
December, because it gave Tellabs new products that enable the convergence
of voice, video and data traffic.
"Early in the next decade, Tellabs should derive a significant portion of its
revenue from switching and next-generation, packet-based equipment,"
Steven D. Levy and other analysts at Lehman Brothers wrote after that
acquisition.
Tellabs already is the number one player in cross connect systems, a
$2.1-billion market in 1999, according to Dataquest. But the real potential
may lie in new optic cross connect systems, which enable faster data
transmission and which Kelly expects to see by year's end.
Tellabs' fans see the stock as reasonably priced.
"We rate [it] a Buy based on its valuation," says Nikos Theodosopolous, an
analyst at Warburg Dillon Read. Its core business, he adds, is doing well. "It's
a cheap stock."
At 61 1/2 late Monday, Tellabs is 20% off its 52-week high of 77 1/4 and
trades at 37x 2000 expected earnings of $1.66, according to First Call.
That's a premium to its annual 2000 estimated earnings growth of 25% and to
its projected long-term annual earnings growth of 30%. But its P/E of 29x
expected 2001 earnings is actually a discount to that long-term growth
projection, as well as to Tellabs' historical P/E of 43x forward earnings.
Says Cena: "It's the lowest in the group, [compared with Lucent, Nortel or
Cisco Systems, which currently trade at anywhere from 41x to 117x this
year's earnings]," he says. "There aren't that many opportunities to pick up a
fallen angel."
Perhaps that's why Kenneth Leon, an analyst at ABN-AMRO, rates Tellabs
his Top Pick for 2000, after upgrading it in December to Buy from
Outperform. (Last year's Top Pick was Nortel, which had a spectacular
1999.)
"[More] visibility in new products [will] get the valuation multiples higher,"
says Theodosopolous. "People want more confidence in some of their new
products."
That's the key risk: Unexpected technological shifts in the rapidly changing
telecommunications business could catch Tellabs flatfooted. Specifically,
growth of voice traffic -- and demand for the equipment that enables -- will
eventually level off, and Tellabs has to get new products addressing the new
markets into the pipeline soon.
But for the foreseeable future, the dial-up Internet infrastructure isn't going
away. And that could lead some investors to come back to Tellabs. |
