From GS:
Tellabs reported 1Q02 revenue and EPS results yesterday of $371M/$0.02, missing our below consensus revenue estimate of $400M, but beating our EPS estimate of $0.01. We continue to believe that revenue declines will outweigh TLAB’s operating leverage in 2003. As a result, we are revising our 2Q02, FY02 and FY03 revenue/EPS estimates to $377M/$0.01, $1.57B /$0.14, and $1.78B/$0.37 from $434M/$0.01, $1.77B/$0.10, and $2.12B /$0.40. We believe the stock has limited upside from current levels. We reiterate our MP rating.
OUR VIEW. Tellabs missed our top-line estimate of $400 million (consensus was $435 million), reporting $371 million for 1Q02, but exceeded our EPS estimate of $0.01 by a penny. We believe continued risk to the top-line, resulting from a slower ramp in new products and
continued fallout in demand for 5500s, will outweigh operating leverage benefits gained from gross margin improvements and restructuring activities. As a result, we have reduced our top-line estimates for FY02 and FY03. We have raised our EPS estimates for FY02 due to the near-term benefit of margin improvement and restructuring, but lowered
them for FY03, as volume declines offset strong gross margins and residual cost savings from restructuring.
Through all of this, the company’s balance sheet remains strong with $911 million in cash.
VALUATION. Using historical FV/EBITDA multiples, we believe TLAB shares at current levels have 13% upside to our $11 12-month price target. Currently, TLAB shares are trading at 15x 2003 FV/EBITDA. In the 1991 to 1994 period, when Tellabs maintained 5% to 10% operating margins and similar free cash flow yields, the company traded near 17x forward FV/EBITDA multiples. Signs of top-line stabilization, further margin expansion, and modest growth going into 2003 are the catalysts for our $11 share price. Given the limited (only 13%) upside from current levels, we would wait for the shares to weaken on further top-line concerns
before getting interested.
We believe the risk of top-line declines still outweighs the company’s strong operating leverage shown this quarter. The company was able to achieve 47% this quarter, partially due to revenue mix (increased 5500 margins and greater mix of solutions revenue) and some residual fixed cost reductions from 2H01 restructuring efforts. We believe these are near-term phenomena and expect margins to trail off a bit in the next couple of quarters to the 45% to 47% level. This, combined with over $100 million in FY02 operating expense benefits from today’s announced restructuring effort (we are targeting $675 in total FY02 opex), will yield near 9% operating margins by year-end FY02.
However, the risk of top-line declines remain real and we believe that any additional volume declines will continue to affect margins. We believe the sources of potential top-line weakness for Tellabs are as follows:
1) New Product Growth Expectations are Coming Down. For the 6500, we believe the large portion of the Sprint spend is over, though Sprint will continue to provide a small and consistent service and upgrade revenue stream going forward. We continue to expect slow and steady Verizon
deployment throughout the remainder of 2002, with the company expected to purchase roughly 40 systems over the next 18 months. Also, we expect only one new 6500 customer to be announced this year. As a result, we are lowering our expectations for new product (6500 and 7100) revenue for FY02.
Our outlook on the 6400 remains the same, $60 million in revenue for the year, and will be looking forward to updates on traction beginning at the end of 2Q02.
2) Existing 5500 Revenue Levels Could Still Go Lower. The level of revenue for the 5500 product line is of primary concern. We are currently estimating that maintenance revenue for the 5500 is approximately $160 million on a quarterly basis. Given the current weak spending environment
and known inventory and capacity issues affecting demand for the 5500, we will be closely monitoring the level of activity surrounding this product line for the remainder of the year. Our FY02 5500 revenue is $658 million.
BALANCE SHEET STILL REMAINS STRONG. Tellabs ended the quarter with $911 million or $2.2 per share in cash. Though cash flow may experience some volatility over the coming quarters, we estimate that Tellabs will yield near 10% free cash flow margins in aggregate in FY02 and FY03.
THE FACTS. Tellabs reported 1Q02 revenue/EPS results yesterday of $371 million/$0.02, missing our estimate of $400 million on the top-line (Street was at $435 million), but beating our expectation of $0.01 (Street was also
at $0.01) on the bottom-line. The company reported gross margins of 47%, above the guided range of mid-40s. The increase in gross margins was primarily due to revenue mix issues and benefits from the 2H01 restructuring. The company plans to reduce its workforce by 1,200 and
close one of its four manufacturing facilities. $240 million in restructuring charges and excess
inventory/commitment charges will be taken as well. On the balance sheet, the company ended the quarter with a strong
cash position of $911 million. The decline in cash was primarily due to the cash payment associated with the Ocular acquisition. DSOs fell to 61,down 3 days sequentially. Inventory turns fell to 2.5x, with inventory
levels down $36 million sequentially. |
