The Descent of Ascend
FOOL ON THE HILL
An Investment Opinion by Randy Befumo
The Descent of Ascend
Uncertainty about when a 56 kilobit-per-second modem
standard will be finalized combined with weak sales in the
month of July has sent shares of ASCEND
COMMUNICATIONS (Nasdaq:ASND) into a tailspin.
Although the nominal cause of today's $2 1/2 decline to $41
3/8 is an about-face on the part of a Merrill Lynch analyst, the
news is another regurgitation of the concern about July sales
first seen when Ascend published its 8-K filing. With Monday's
Network World revealing that the basic intellectual property for
56K modems may actually be in the hands of a foreign national
and not any of the companies currently involved in the
standards setting process, there is even more concern now that
Ascend's sales over the next few months could be slower than
expected.
Ascend revealed on August 11 that "[f]or the 31-day period
ended July 31, 1997, Ascend Communications, Inc., a
Delaware corporation, had consolidated net income of
approximately $2.9 million and consolidated sales of
approximately $62.8 million." With Ascend having 188.4
million shares outstanding as of its last quarterly filing, this
implies that Ascend only made one and a half cents per share in
the first month of the third quarter, leaving thirty-three and a
half cents per share to go if it is going to meet current analyst
earnings estimates. Although Ascend's quarters are typically
"back-end loaded," meaning that it does most of its business in
the final weeks of the quarter, investors have been increasingly
unwilling to tolerate any uncertainity from networking-related
companies after the entire group got mashed last April.
Investors may be right to worry. With Ascend's net sales for
the second quarter at $311.7 million, the company's July sales
only approximate 20% of last quarter's earnings. To match
expectations of sequential sales growth, the company will have
to more than double July sales in August and September.
Ascend has historically done a huge hunk of business in the
closing days of the quarter, but it has not done so with business
at the company's new Cascade unit in the dumper and the
continuing squabble over 56K technology. Monday's Network
World bombshell indicating a 56K standard may take more than
a year to materialize only further erodes confidence.
While there has been a mass proliferation of wide-area network
(WAN) technology to allow for remote access and expand the
public network called the Internet, many providers have been
waiting for the international standards committee to come up
with one 56K standard before fully deploying the technology.
However, a relative unknown in technology circles named
Brent Townshend now claims to have a broad patent filing on
basic 56K pulse code modulation modem technology. A
committee member for Inter-national Telecommunication
Union (ITU) has contacted Townshend and reported that he
seems open to licensing his patent, but the modem-gear
manufacturers may prefer to take this to court rather than
paying what could be hundreds of millions of dollars in royalties
based on the patent.
Originally the ITU had planned on formalizing the modem
standard in September, the last step before it would be finalized
in January. With one formal standard, many companies reliant
on wide-area technology would have felt comfortable buying
either Ascend or U.S. Robotics/3Com remote access gear
knowing that it would all be interoperable. Now those same
people are expressing some concern over mass deployment of
one standard when the standard could change, leaving Ascend
in a bind because of its decision to license the Rockwell/Lucent
56K technology over the U.S. Robotics/3Com technology.
Even if Townshend agrees to license his patent, it is unlikely
that the major modem manufacturers will let the patent stand
without a fight. Les Brown, chairman of the ITU committee,
still hopes a 56K modem standard agreement can be reached
next month, but investors are discounting shares of Ascend as
they perceive that the inherent risk as rising.
With $311.7 million in sales last quarter, Ascend's annualized
revenues are approximately $1.3 billion. With the stock
currently at $41 3/8, the company is capitalized at $7.8 billion
less $562.1 million worth of cash on the balance sheet, or 5.8
times annualized revenues. The company is trading at 33.4
times its annualized earnings from last quarter (netting out
charges for the merger with Cascade Communications), but the
valuation really only holds up if Ascend can generate the kind
of growth that its current earnings estimates call for.
As it stands, Ascend will only increase earnings by 16% to
$0.36 per share if it makes its quarterly estimates, although this
would also be a 16% sequential improvement (including the
weak Cascade results). This is certainly possible if Cascade's
business has improved as advertised, but if the standards
shuffle puts any pressure on sales, the company could easily
fall a few pennies short of the estimate and see its P/E multiple
continue to shrink. Even trading in the low $40s, the shares
require a time horizon of longer than a year and a tolerance for
volatility.
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