CLRN report on invest tools. Pretty good report:
This Months Recommendation
Clarent Corp.
700 Chesapeake Drive
Redwood City, CA 94063
Tel: 650-306-7511
clarent.com
Nasdaq Symbol: (CLRN)
Price: 12/6/00: $16.81
Recommendation
Clarent Corp.’s Nasdaq: (CLRN) goal is to make communications more efficient. The company provides network management software and gateways that are the backbone of all Internet-based voice exchanges. The firm’s technology allows for the simultaneous exchange of voice, faxes and data over the same network. This seamless operation is a major cost-saver for small service providers that find it difficult to compete with the large national monopolies.
The third quarter was another blowout for Clarent. First, the company posted a cash profit of $0.04 per share compared with Wall Street’s projected loss. Revenue increased 60% on a sequential basis to $45.5 million, thanks in part to a significant new contract from China Mobile, which accounted for 22% of Clarent’s revenue during the quarter. Mobile plans to make large deployments of the company’s voice-over-IP (VoIP) products in mainland China.
Gross margins decreased 450 basis points to 56.3%, as the recently-acquired ACT Networks enterprise products are generally less lucrative than Clarent’s own offerings. Software revenue was strong at $13.7 million, or 30% of earnings. This figure should continue to rise and perhaps even equal hardware sales before the end of 2001, and margins could once again approach 60% within the same time frame.
Service revenue also grew significantly, to nearly 13% of total sales. This figure continues to improve at a multi-triple-digit pace (year-over-year), and should sustain that rate as Clarent’s established client base matures and requires more outsourcing services. This growth should help to smooth out customer revenue concentration, which is often skewed when a single firm makes a large initial hardware/ software purchase.
The stock has recently experienced serious selling pressure, but most of the tax-loss selling is over for the year, and the market may be generally oversold. If the major indices do begin to capitulate, Clarent’s growth, market leadership and cash position all make the stock a prime candidate to rebound next year.
In May, Clarent paid $142 million in stock for ACT. Ironically, ACT has twice been a selection of the SSR portfolio, most recently losing 55% between August 1996 and August 1997. SSR believes that the merger will be a positive event for Clarent, although the integration of ACT’s enterprise business will dilute the company’s overall margins. The company had approximately $50 million of revenue in the four quarters prior to the merger, and should help solidify Clarent’s relationship with a new set of enterprise customers.
ACT’s products will open new doors, as they function over frame-relay and ATM networks. The mergeralso gives Clarent an extended geographic presence in Latin America. In addition, the company has existing relationships with major telecom players like Sprint NYSE: (FON) and Worldcom Nasdaq: (WCOM). The deal closed in August, and is likely to become accretive in the coming fiscal year.
Clarent currently derives about 20% of its total sales through strategic partners in its sales network, while ANET received almost three-quarters of its revenue from channel partners. These relationships should be a key driver of promoting the Clarent brand going forward, and offer another avenue of future sales growth.
The purchase of PEAK Software in July should help Clarent accelerate its entrance into the wireless market. PEAK was acquired for approximately $60 million in cash and stock, and will strengthen the company’s software R&D team with more than 50 new engineers.
In addition to its already successful long-distance business, Clarent hopes to begin its push into the local telephone markets in China and Taiwan. Clarent also has an alliance with Maxlink Communications to provide for broadband wireless loop technology in Canada, a contract that could be worth a total of almost US$70 million over the next five years.
Clarent receives less than half of its sales from North America, and is subject to fluctuations in the world’s major currencies. The U.S. dollar’s strongest days seem to be over, which could bode well for the company’s aggressive overseas expansion plan over the next few years.
Thanks to a defensive follow-on offering in November 1999, Clarent has a robust cash position of $287 million ($7.38 per share) and no long-term debt. This will give the company room to grow through marketing and R&D expenditures in the coming years. Management has yet to complete any debt financing, which leaves the company with a pristine balance sheet and plenty of room for future potential leverage.
Clarent has already turned a cash profit (excluding the amortization of stock options) in the first three quarters of fiscal 2000, but will likely dip back into the red in the fourth quarter on increased R&D expenditures. SSR believes that the current Street estimate for a $0.04-per-share loss is conservative by two pennies. This would still give the company an EPS of $0.07 for 2000, which could improve to a full $0.25 next year.
Clarent completed its IPO in June 1999 at $15 per share. The company’s stock rose to a high of $178.75 in March, and has since retreated to $16.81. With a short but consistently strong operating history, the stock has been unjustly oversold in the market downturn of recent months, and investors should purchase shares now for the likely possibility to realize sizable gains in the next few years.
--------------------------------------------------------------------------------
Business Description
The company was founded in 1996 as NetiPhone, and was later reincorporated as Clarent in 1999. The company began shipping products in 1997, and now offers service providers end-to-end VoIP solution.
Clarent serves many of the world’s largest long-distance carriers, including AT&T NYSE: (T) and British Telecom NYSE: (BTY). The company has made an exceptionally strong push into China and Taiwan, and counts China Telecom and China Mobile as two of its largest customers. Both use the company’s products in domestic and international networks-a relationship that could create much recurring business in the future.
The Clarent System consists of three integrated pieces, which are also designed to work with other companies’ hardware. The "command center" is a software package that manages the entire network by communicating with the gateway hardware and tracking, routing, and billing every call entered into the system. The gateway converts voice, data or faxes into packets for transporting around the network, and the relational database stores these settings and information for each customer. As Clarent works to broaden and improve its hardware and software, the company’s value-added system will likely gain appeal in the telecom industry.
Clarent also has a broadband strategy that currently has a primary focus on the DSL market. Clarent has a few deals inked in this space to-date, and the company’s local exchange business may never be as successful as its forays into the VoIP industry. While still a few quarters off into the horizon, a sooner adoption and build-out of these services could make everyone’s earnings models prove to be on the conservative side.
--------------------------------------------------------------------------------
Industry Outlook
The VoIP industry is relatively young, and was formed as a hybrid of the voice-telecom business. Compa-nies like Clarent figured that the common packet-switching technique used to carry data and faxes over the Internet should one day be able to carry voice transmissions over the same network. The tricky part was to make the process seamless, and to sound as clear as existing phone lines. The VoIP industry targeted the long-distance carriers first, as the maturing businesses were trying to upgrade their technology. These firms are facing sagging profit margins, and therefore switching their systems over to this cost-saing technology.
Many analysts believe that the next step for the equipment makers in the VoIP industry is to adopt their products for service providers on DSL or even wireless broadband networks. But with low penetration in the long-distance-carrier space, there is room to grow in the core market until the next-generation products are ready for the market upgrade.
The flood of companies to enter this space in a short time has also caused numerous failures, and subsequently consolidation within the industry. Clarent has started its own buying spree, and has the bank account to make more purchases as management sees fit. The Big Three (Cisco, Nortel, and Lucent) also never lose their apetite for acquiring beaten-down telecom companies.
--------------------------------------------------------------------------------
Management
Jerry Chang
President, Chief Executive Officer, Director
Mr. Chang is one of the co-founders of Clarent, and has served in his current positions since the company’s inception in 1996. Prior to 1996, he gained software development experience at Relations Software, OnLive! Technology, and Centura Software.
Richard J. Heaps
Chief Financial Officer, Chief Operating Officer, General Counsel, Secretary
Mr. Heaps has served in all of his current positions since he joined Clarent in September 1998. Imme-diately prior that, he worked as an independent consultant in Silicon Valley. Mr. Heaps also has nearly a decade of experience at Centura Software, including management positions such as senior vice president of business development and general counsel.
Michael F. Vargo
Chief Technology Officer, Senior Vice President, Director
Mr. Vargo is also a co-founder of Clarent, and has served as the company’s chief technology officer ever since. He assumed the role of senior vice president in July 1999. Mr. Vargo also has engineering experience at Oracle Corporation Nasdaq: (ORCL) and spent seven years at Pacific Bell.
Andre de Fusco
President of ACT Networks
Mr. de Fusco was appointed as a member of the board of directors, president and chief executive officer of ACT Networks in July 1998, and will continue to manage this company as a division under the Clarent umbrella. He held various other management positions at ACT since joining the company in December 1994. Previously, Mr. de Fusco also served as director of business development at Nortel Networks NYSE: (NT).
--------------------------------------------------------------------------------
Insider Ownership
As of the latest proxy statement of April 2000, insiders owned just over eight million shares, or 24.7% of the stock outstanding. Co-founders Jerry Chang and Michael Vargo each own well over two million shares, and control about 7% of the company. Insiders and beneficial owners have been net sellers throughout 2000, but still maintain considerable stakes in the firm. It would not be surprising to see some insiders buying shares or a company-sponsored stock-repurchase program if Clarent remans relatively undervalued in today’s market.
Institutional holdings have in-creased sequentially for each of the last three quarters, and stood at 40% of the shares outstanding on September 30. Fidelity holds an 8.6% stake in Clarent, down from 10.5% in the prior quarter. Pimco Advisors is listed as the next largest institutional holder, and purchased its entire 3% investment in the most recent quarter.
SSR believes that calendar-year-end data will show that institutions were net sellers of Clarent in their fiscal fourth quarter, which helped to bring the stock back below its IPO price in late November.
--------------------------------------------------------------------------------
Risks
Clarent is a volatile stock in a volatile industry. For one thing, there is no guarantee that VoIP will be the standard of choice for long-distance carriers in the future. For another, the carriers are facing shrinking profit margins, and may cut back on their expenditures in 2001.
The company has also been relatively immune to the overall slowdown in telecom spending, especially when it comes to the long-distance carriers. Many of Clarent’s customers have already experienced the value-added services available through the company’s solutions, which makes the expenditure a priority for firms facing the prospect of declining profits in the coming year.
3Com Nasdaq: (COMS) also just issued a profit warning on December 4, which was mainly due to a decrease in spending from the large long-distance service providers. Again, most of 3Com’s products were for legacy voice networks, and Clarent through its leadershio in the VoIP market should be one of the last equipment providers to feel this spending crunch.
Investors should not be overly concerned by this concentration of revenue during the quarter. Clarent had approximately 550 customers at the end of the third quarter, including 250 new accounts that were created during the period. Besides China Mobile, only one other customer accounts for more than 10% of total sales, and the next eight largest accounts comprised less than 40% of revenue.
But readers need look no further than Harmonic Nasdaq:( HLIT) to find a once-large, fast-growing tech firm that was literally crippled during 2000 when AT&T (also a large customer of Clarent’s) decided to cut down on its orders. Harmonic had relied on the company for about 40% of its total sales, and suffered because it could not attract other customers before AT&T fell into trouble.
Finacial Highlights
Operating Data,
Years Ended 12/30 1997 1998 1999 2000** 2001**
----------------- ---- ---- ---- ------ ------
Revenues 3,359,000 14,647,000 47,823,000 153,000,000 310,000,000
Operating income (loss) (1,559,000) (5,824,000) (33,163,000) 1,800,000 11,800,000
Net income (loss) (1,489,000) (5,832,000) (30,783,000) 1,800,000 11,800,000
Net income (loss) per share (1.55) (1.65) (1.87) 0.09 0.25
Three Months Nine Months
Reporting Period Ended 9/30 1999 2000 1999 2000
--------------------------- ---- ---- ---- ----
Revenues 13,227,000 45,523,000 29,245,000 98,419,000
Operating Income (loss) (4,866,000) (11,207,000) (27,751,000) (19,925,000)
Net income (loss) (4,222,000) (18,130,000) (27,265,000) (18,618,000)
Net Income (loss) per share (0.17) (0.50) (2.17) (0.55)
Balance Sheet 9/30/00 Pricing Statistics (U.S. Dollars) Valuation Statistics
--------------------- --------------------------------- --------------------
Cash & equivalents 286,635,000 52-week high: $178.75 Price/earnings: NM
Total current assets 350,312,000 52-week low: $11.63 Price/book 1.3x
Total assets 555,372,000 Recent price: $16.81 Price/sales: 5.6x
Total current liabilities 49,956,000 Shares out: 38,917,000
Long-term obligations Nil Insider ownership: 25%
Total liabilities 49,956,000
Shareholders’ equity 489,506,000 Valuations based on latest 12-month results.
--------------------------------------------------------------------------------
Competition
Clarent is the largest major pure-play VoIP firm in the stock market today. The company competes directly with smaller units of telecom giants like Lucent NYSE: (LU), Cisco Systems Nasdaq: (CSCO) and Nortel Networks. When this becomes evident, more investors will be clamoring to hold the largest pure-play in the lucrative VoIP business.
Clarent believes that it holds a first-mover advantage in its young, competitive market. There is no doubt that this has aided the firm’s meteoric rise in the last two years, especially given the fact that many of its new competitors are household names.
SSR believes that Clarent can hold its own against the much larger competition. The company has the leading technology solutions for the VoIP market, which may eventually make Clarent a potential takeover target itself.
The pricing structure on the hardware side of the industry is declining. So far, Clarent has been successful in selling software and services to make up for lower selling prices of its VoIP ports. It is not surprising that prices are dropping, especially as Clarent moves into the hyper-competitive Asian markets. There are many smaller companies that can offer the same services in nearly every global market, yet Clarent continues to win customer orders.
--------------------------------------------------------------------------------
Projections
Clarent is growing revenues at an estimated rate of 100% annually. Between the secular growth rate of the VoIP industry and the company’s leading end-to-end solutions suite, SSR believes that this pace is realistic. Clarent is still posting sequential revenue growth in each quarter, and SSR believes that the streak can continue through 2001.
Another barometer of Clarent’s financial well-being is the company’s accounts receivable. In the most recent quarter, Clarent’s days sales outstanding (DSO) was 92 days- above the industry average and otherwise high for any company. Clarent believes that this figure is due in part to overseas business, which is more credit-based. SSR believes that Clarent’s receivables are relatively secure, and that the company will not likely have to writeoff any material amount of its customers’ payments. Management’s near-term goal is to keep this figure at or below 90 days of sales.
Before the ACT acquisition, management felt that it could push the gross margin into the low-60% range. The company should still see a relative improvement in this figure, as Clarent receives an increasing amount of its business from higher-margin sources like software and services. Clarent can further leverage its sales by realizing operating synergies from both of its recent mergers once management cuts back its high R&D spending in the second half of fiscal 2001.
One major catalyst for Clarent in 2001 will be the release of its next-generation VoIP platform in the second quarter. The company expects that it will be able to expand the scalability of its gateways more than five-fold, to 1,920 ports. This will be just one of many changes, as the entire Clarent system will receive a face-lift over the next few quarters. Not only does the upgrade provide a chance for existing customers to add to their existing business with Clarent, but the new products should boost the company’s brand with potential customers and investors.
SSR believes that Clarent can continue to show 20% sequential im-provement in the fourth quarter, and could post revenue of $54.6 million. This would give the company a total of $153 million in sales for fiscal 2000, which could double once again to nearly $310 million next year.
At $16.81 per share, Clarent is valued at about 2 times projected 2001 sales of $310 million, and only one times next year’s projected sales in the core business. When compared with other emerging telecom/networking companies like Extreme Networks Nasdaq: (EXTR) and Foundry Nasdaq: (FDRY), the stock looks grossly undervalued. Given the company’s large cash position and no debt, Clarent stands head-and-shoulders above many other young technology companies. |
