7/19....FDRY... Will Foundry Networks Come Back?
Research Director: David Sterman (07/19/00)
In recent quarters, the earnings season has taken on a new wrinkle. Fast-growing, high tech outfits post very impressive numbers, and then watch their shares get crushed.
More than two dozen tech stocks have slid more than 15% in one day after handily beating both published and whispered estimates.
Don't blame it on the analysts. They continue to publish very conservative estimates, and write glowing reports right after the quarterly release.
Instead, momentum investors are the likely culprit. These folks don't actually fundamentally assess the strength of a given quarter, they just move on to the next hot stock. After all, once a company has released earnings, additional positive news is likely several months away. And in the momentum world, several months is a lifetime.
But that makes life a bit easier for the rest of us. We're all looking for quality companies that deliver. Unfortunately, the best ones often carry lofty stock prices. We wait and hope that a minor bit of bad news will create an entry point for the stock. But as noted above, you can sometimes get a stock at a discount, even though the news flow is quite positive.
Foundry Networks (NASDAQ:FDRY - news) fits that thesis nicely. After the close of trading Tuesday, the switch-and-router maker reported a very impressive second quarter. So what happened? The stock plunged $23 as soon as trading opened Wednesday. Go figure.
You'd think the company dropped a bomb. Au contraire.
We got a chance to speak with Foundry's chief executive, Bobby Johnson, on Tuesday night (well, it was night time on the East Coast anyway). We came away with a singular impression: Foundry has a lot of opportunities on its plate and is executing its business plan to a tee. (But we also noticed that Johnson is not given to hyperbole and animation as most CEOs are, which might also explain the stock drop).
Foundry, as chronicled in a recent piece, is a small, but rapidly growing player in the massive Internet switch and router market. Along with firms such as Extreme Networks (NASDAQ:EXTR - news), Juniper Networks (NASDAQ:JNPR - news), F5 Networks (NASDAQ:FFIV - news) and Alteon WebSystems (NASDAQ:ATON - news), Foundry is nipping at the heels of Cisco Systems (NASDAQ: CSCO - news).
Given the market's size and rapid expansion, there's room for several players to thrive. Several, but not all. That's why investors scour quarterly growth rates for any clues.
By that measure, Foundry looks to be quite healthy. Second quarter earnings of $0.19 per share were up 400% from a year ago and nearly 20% ahead of published estimates.
Sales of $88 million were up 27% sequentially, almost the exact sequential growth rate the company posted in the first quarter. In other words, Foundry isn't slowing down, even though it's working off a growing sales base.
Because of the positive surprise, analysts now figure that Foundry will bag $375 million in sales this year, up from a prior expectation of $341 million. By comparison, Foundry had sales of $133.5 million last year. There's no reason that the explosive growth won't keep up next year, considering Foundry is still ramping up its sales force. The company is guiding analysts to look for sales of $590 million in 2001. After this morning's sell off, Foundry now trades for 22 times that estimate, which is actually quite cheap for this sector.
Nearly two-thirds of Foundry's gear now goes to Internet Service Providers (ISPs). Outfits such as America Online (NYSE:AOL - news) , Exodus Communications (NASDAQ:EXDS - news), and Earthlink (NASDAQ:ELNK - news) are rapidly beefing up their networks ahead of an expected surge in broadband services.
Foundry's products, which are widely considered to be superior on a price/performance basis, are all set up for an upgrade later this year, according to CEO Johnson.
The large ISPs are a natural market for Foundry, as the company is still somewhat constrained by the lack of a sufficiently large sales force. As new feet hit the street, the company should be able to beef up sales to other types of customers as well. But Johnson figures that ISPs will still account for roughly two-thirds of sales for the remainder of this year.
But Foundry still has room to improve. Accounts receivables are growing slightly faster than sales, although they are at a still-reasonable 47 DSOs, or days sales outstanding.
Inventory turns, which were an amazing 4.9 times in the first quarter, slipped to 4.4 turns in the second quarter. And the company's customer base should be more diversified, although no customer accounts for more than 10% of sales. That won't happen until the sales force is truly up to speed.
As Johnson concedes, the large ISPs don't always provide great visibility on their capital expenditure plans. ``Some give us as much as 6 to 12 months visibility, while others just go a quarter out,'' he says.
Bottom Line:
All of the stars are aligned for Foundry to grow at least 20% sequentially for the next three or four quarters. If you've been waiting to buy this stock at an attractive price, don't wait much longer.
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