From GS:
We estimate that Tellabs will incur a 4Q02 loss of ($0.04) on revenues of $277 million.
The story for Tellabs remains essentially unchanged in our view: strong financials, great
customer relationships, but not enough growth in new-product revenues to offset a
slowdown in the company's core digital cross connect business. We believe 4Q02 results
will be in-line with expectations and that operating expenses should be about flat with
those of 3Q02. We are forecasting a 4Q02 EPS loss of ($0.04) and revenues of $277
million, which would give the company a full-year 2002 EPS loss of ($0.06) and revenues
of $1.28 billion. Our 2003 EPS estimate remains unchanged at a loss of ($0.09) and we
are establishing a FY2004 EPS estimate of $0.03 on revenues of $1.17 billion. We rate
TLAB shares U/C.
QUARTERLY OUTLOOK. We estimate that Tellabs will incur a 4Q02 loss of ($0.04) on
revenues of $277 million (revenues will be down about 4% sequentially and down 41%
YOY). We expect operating expenses to be essentially flat quarter-to-quarter. Fortunately,
management began taking appropriate cost-cutting action back in 2001, which in our view
has enabled the company to come close to a cost structure that accommodates toady's
lower-volume environment. Despite this however, end-market demand for legacy
equipment such as digital cross connects remain weak. Furthermore, new products (i.e. the
6000and 7000 series), which are being positioned to offset legacy product sales,
comprised only 5% of total revenues in 3Q02. The 4Q02 consensus EPS and revenue
estimates are a loss of ($0.03) and $283 million, respectively.
OPTICAL NETWORKING. This segment(about 40% of total firm sales) is expected to decline 6%
sequentially to $108 million, down from $115 million in 3Q02. Weakness in this division continues
to falter due to diminishing TITAN 5000 series sales. The TITAN 5000 series enjoyed strong sales
when second-line growth was being spurred-on by dial-up internet access and thanks to the
build-out of wireless networks. Now that the growth of these two phenomena have drastically
slowed, it will be imperative for Tellabs to find another market opportunity. The company has
introduced products such the TITAN 6500 and Ocular's 6400, however revenues associated with
these and other new products remain minimal.
BROADBAND ACESS. This segment (about 38% of total firm sales) is expected to decline 7%
sequentially to $107 million from $112 million. We expect the TITAN 8000 series (formerly
MartisDXX) to continue to be weak in light of its exposure to Europe and we believe the TITAN
2000 series (formerly CableSpan ) will continue to be healthy.
VOICE QUALITY ENHANCEMENT. The segment 4% of total firm sales) is expected to decline
7% sequentially to $12 million from $13 million. This segment is currently comprised of the
TITAN 3000 series, which is Tellabs' echo- cancellation product line. Echo-cancellors have been
around since the late 1970's and are primarily used in long-distance networks to compensate for
delay in international calls. We believe there will be limited demand for this product due to the
extensive network upgrades that have occurred over the past decade. Beginning in 2003, Tellabs
will no longer break-out this product-line but will include it in Broadband Access instead.
Services (17-18% of total firm sales) are expected to stabilize at about $50 million next quarter,
however sales for this segment are down 22% YOY.
EARNINGS ESTIMATES. We are forecasting a 4Q02 EPS loss of ($0.04) and revenues of $277
million, which would give the company a full-year 2002 EPS loss of ($0.06) and revenues of $1.28
billion. Our 2003 EPS estimate remains unchanged at a loss of ($0.09) and we are establishing a
FY2004 EPS estimate of $0.03 on revenues of $1.17 billion.
VALUATION. Firm-Value/Sales (FV/S): based on a normalized FV/S estimate, Tellabs' current
stock price of $8.92 implies a FV/S multiple 2.2x, which is a healthy premium to its historical FV/S
multiple of 1.2x, which implies a current valuation of approximately $6.00. Based on this method,
we believe the stock is trading at an unsustainably high price in the near- term.
What are normalized net income margins for Tellabs? We estimate that Tellabs' normalized net
income margin at 18%-19%. From 1989 to 1995 net income margins grew from single digits to
18.2%. From 1995 into the bubble, net income margins were largely in the low 20% range. This
strong performance was backed by a great amount of pricing control, a focused and limited product
line, and a dominant market share position. While we believe Tellabs can achieve high-teen net
income margins over the long- term, given its need to expand its product lines and enter new
markets we believe it will difficult to repeat the successes it achieved in the digital cross connect
market in the late 1990's.
How much could Tellabs earn in a recovery scenario? Given our 18 to 19% normalized net income
margin assumption, Tellabs' earnings potential under a full recovery scenario is $0.49 to $0.53 per
share. This assumes a revenue level of $1.2-$1.3 billion.
What's the implied multiple and what are historic multiples? At $8.92, Tellabs is trading at 17 to 18
times its normalized earnings power of $0.49 to $0.53, earnings levels that in our view will not
likely be achieved until 2006 or later given the company's current and needed product transitions.
Historically, Tellabs' pre-bubble average multiple was 12 to 15 times, and in the late 1990's it was
27 times. During this period Tellabs was growing its earnings over 30% on average. Despite our
view that Tellabs has a solid management team, strong balance sheet, and strong execution skills,
the price is not warranted in our opinion given end- market risk and risks related to
product-expansion.
Cash management is not an issue for Tellabs, in our view. |
