<font color=red>Kaufman Bros Upgrade to Strong Buy, October 3, 2000
REVISITING STRONG BUY RATING BASED ON LONG-TERM FUNDAMENTALS
Since our cautionary note on September 1, shares of Netopia have been on a downhill slide as investors have become disenchanted due to near-term concerns over the September quarter. Specifically, shares are down 73% since our downgrade
and down almost 90% since it hit a 52-week high in early March. While Netopia most certainly did enter the third month of its quarter behind schedule, the fact that the company has not pre-announced should be viewed positively as the company is apparently sticking to its prior guidance.
We wish to revisit the concerns we raised in early September:
The DLECsí ability to get financing in the capital markets. To be sure, this concern is paramount with regards to investorsí evaluation of Netopiaís long-term prospects in the DSL CPE space. We believe there are three points to address with respect to this issue. First, investors must remember that CPE, such as that from Netopia, is a necessary part of a DSL service providerís ongoing business. In other words, the service provider must continue to add new subscribers to continue operating and to do that they must continue to purchase and deploy CPE; unless they are completely folding and going out of business, they will continue to buy CPE. Second, the investment community should pay attention to financings and realize the well is not dry. While the cost of capital is certainly greater and the capital markets tighter, the fact remains that companies are still raising money. Network Telephone, a service provider that operates in the BellSouth (BLS $41 7/16) territory, raised $256 million in early September including $156 million in equity and $100 million in senior debt. Netopia announced Network Telephone as a customer in early August. Third, investors are well aware of the recently announced deals with SBC Communications (SBC $50 1/16) and Covad Communications (COVD $12) and Verizon Communications (VZ $47 3/8) and NorthPoint Communications (NPNT $8 15/32). As these were Netopiaís largest customers last quarter, we believe this bodes very well for the CPE vendor. In addition, we would expect to see continuing consolidation in the service provider space as large incumbents look to expand local presence in out-of-region territories and PTTs and IXCs look to enter the local markets. The next wave of acquisitions and partnerships will likely leave room for smaller players to step up and establish presence in the marketplace.
The Verizon Strike. While the Verizion strike certainly had its impact on a number of DSL providers such as Covad and NorthPoint, after talking with a number of carriers and industry sources, we believe the strike had only a limited effect on deployments and, with a pick-up in installation during September, has largely been resolved.
Provisioning. This seems to be the largest focus for the carriers as they attempt to ramp installations to a point where they can go from thousands of installs a week to tens of thousands per week. While things seem to be improving, it continues to be a slow and difficult process. Of note, Covad, since lowering its guidance in June, has since come out and preannounced line installations that would significantly exceed the lowered guidance. We are moving in the right direction.
Pricing. As we pointed out in our last note, the majority of the price erosion occurring in SDSL CPE has come from the lower end SDSL bridges/modems. Netopia has not, does not and, according to the company, has no plans to compete in this space. We do not see pricing as a major issue for Netopia for this quarter or for the foreseeable future.
Verizonís Acquisition of NorthPoint. While this deal may have brought with it some short-term concerns over whether this restructuring would cause a slowdown, we believe longer term it will prove to be a home run for Netopia.
INVESTMENT CONCLUSION - A DIAMOND IN THE ROUGH
As our September 1 note articulated, we continue to be bullish on the long-term prospects for Netopia. This is a standalone company run by a strong management team that has a healthy balance sheet and is today cash flow positive. More importantly, the company has a solid product line and relationships with all the right channels and has gained market share in the DSL router space in each of the past several quarters. We expect that to continue. We view the recent selling pressure as well-directed but overdone, and point to the fact that the S&P500 is currently trading around 23x 2001 EPS estimates. Netopia is now trading at less than half that multiple based on our 2001 calendar year estimate. Based on solid fundamentals, a strong leadership position in the market and a positive long-term outlook, we are raising our rating on shares of Netopia from BUY to STRONG BUY. |
