Good Report: From Raging Bull to EFNT Yahoo to WSTL Yahoo to SI
UBS Warburg August 18, 2000
Anton Wahlman 212 821 3675 Jeffrey H. Susman 212 821 3458
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ADVENTURES IN DSL LAND: STOP WORRYING SO MUCH
" SUMMARY:
In this note we bring up a long list of recent worries about the DSL market,
from inventory concerns to strikes and the international markets. We show that
Korea alone is adding more subscribers than the U.S. market, and that Deutsche
Telekom recently procured what we believe could be as many as 2m ADSL modems
from Siemens, which in turn is using a Texas Instruments PHY and a Virata
network processor in every modem. In addition, while both Verizon and SBC have
their issues in terms of being able to buy significantly larger quantities of
modems in the September quarter, our estimates for both Westell and Efficient
are also very conservative.
HIGHLIGHTS:
* Efficient Networks (EFNT-$53-Buy) and Westell (WSTL-$16-Strong Buy) have been
weak in the last couple of weeks, amid worries regarding SBC's DSL business and
the Verizon strike. Specifically, the worries appear to have been that SBC has
had problems provisioning service, and that therefore inventories have been
built up, which would threaten future Efficient/Westell shipments.
* The inventory concerns primarily in SBC, but also in Verizon, also stem from
the mathematical relationship between the number of modems shipped by
Westell/Efficient into SBC in the June quarter, and the number of subscribers
added by SBC in that June quarter. Specifically, SBC added 200K subscribers in
the June quarter, while we believe Efficient and Westell each shipped around
200K modems, i.e., in total 100% more modems shipped than customers signed on,
disregarding other smaller vendors to SBC. We believe this pattern is not
necessarily unnatural, as SBC in the March quarter signed on 85K subscribers,
and we believe SBC will sign on even more subscribers in the September quarter
than in the June quarter. In addition, it may very well be appropriate for SBC
to carry some inventories, and that they are just now building up such an
appropriate inventory level. For example, assume for a moment that SBC has
1,000 installers and that each installer carries 50 modems in the truck and has
50 more modems at a warehouse. That example yields an inventory level of
100,000 modems alone, and surely SBC has well more than 1,000 installers in its
territory, which covers approximately 35% of the U.S. population, if not more.
* Clearly, SBC has had a hiccup in its DSL installations over the Summer, as it
transferred this business to a separate subsidiary around June 1. However, we
believe that this problem is relatively temporary, and that SBC should be able
to continue its ramp of DSL installations. In the meantime, ISP Jump.net issued
a press release two weeks ago saying that it had halted submissions of DSL
orders to SBC because SBC's subsidiary was taking a long time to process the
orders, and that it had sometimes misdirected the orders to sign up the wrong
ISP.
* In terms of the Verizon strike, the market seems to believe that there is no
DSL installation activity underway. Anecdotal evidence suggests that some DSL
installation activity is indeed going on. For example, a phone call to various
Verizon territories today tends to yield a customer service representative
willing to sign you up for service to be up-and-running in 3-4 weeks, which in
turn appears not much different from the situation six months ago. This tells
us that at least some key personnel at Verizon are not on strike. Customers are
being strongly encouraged to self-install the modem, and sometimes the customer
service representative mentions a $100 fee and a 1-3 week delay in service if an
installer is wanted.
* We believe the chief external ADSL modem vendor to both Verizon and SBC is
Westell, and that the second largest vendor in both instances is Efficient
Networks. We believe that Westell in the June quarter surpassed Efficient in
the SBC account for external ADSL modems, if ever so slightly.
ANALYSIS:
* We also feel it is appropriate to highlight our disagreement with the focus on
the U.S. market in terms of overall DSL market revenue. We believe that the
U.S. market added 500K or fewer DSL subscribers, of which 400K or fewer ADSL
subscribers, in the June quarter. In the same quarter, we believe Korea alone
added 570K ADSL subscribers. For the September quarter, we believe that the
U.S. will add fewer than 700K DSL subscribers, of which 500K should be ADSL. In
the meantime, Korea should add at least 700K ADSL subscribers alone. In
addition, Siemens won a $600m order with Deutsche Telekom, which we believe
includes as many as 2m ADSL modems, each containing a $15-$20 Virata (VRTA-$62-
Strong Buy) chip. This could mean $35m in chipset revenue for Virata over some
period of time. In the June quarter, Virata recognized a total of $21.5m of
chipset revenue.
* In terms of Westell's and Efficient's modem/router revenue, we believe
Westell shipped 335K ADSL modems in the June quarter, and our estimate for the
September quarter indicates a very modest increase to 380K ADSL modems. We
believe Efficient shipped no more than 500K ADSL modems in total - external and
internal combined - in the June quarter, and we estimate that Efficient will
ship no more than 600K ADSL modems in total in the September quarter. Given
where the global market is going with the DSL broadband access revolution, we
view our estimates for Westell and Efficient as highly realistic - in particular
Westell's. Despite all the fears surrounding the Westell quarter, we believe
that the risk/reward ratio is very favorable given the depressed sentiment and
the very low valuation of less than 1x estimated CY02 sales and less than 10x
estimates fully taxed CY02 EPS.
* As we have been saying, we do not view the outlook for global DSL subscriber
numbers to post the chief risk to Efficient and Westell stock, but rather the
challenge over time we believe will be new entrants in the marketplace. Such
new entrants, and their IPOs to raise visibility, we believe pose a more
appropriate danger to DSL CPE stocks than worries about subscriber sign-ons,
strikes and channel inventories at this point.
* On another front, Copper Mountain (CMTN-$62-Hold) stock has recently been
weak, primarily on worries that OEM partner Lucent (LU-$44-Hold), which
constitutes 29% of Copper's sales, is seeking to dissolve this relationship. To
us, this is nothing new, as indeed Lucent one year ago launched its Stinger
product, which is obviously the platform Lucent would rather sell due to its
superior gross margin characteristics for Lucent (no OEM involved). Over the
last year, however, Copper's business with Lucent has grown at least as fast as
the rest of the company, which we believe is a reflection of the attractive
technical characteristics of the Copper DSLAM. Nevertheless, it should not be a
surprise that this relationship should wind down over time. In the meantime,
Copper recently signed on 3Com (COMS-$17-Hold) and Marconi as OEM partners, and
we believe it would be reasonable to assume that these two new partners should
be able to approximately make up for the disappearance of Lucent over time.
UBS Warburg LLC or a predecessor firm has acted as manager/co-manager or
placement agent in underwriting securities of VRTA or one of its subsidiaries in
the past three years.
UBS Warburg LLC usually makes a market in the securities of VRTA, WSTL and
COMS.
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end.
All the best,
Michael |
