Telecom Networker In The Turnaround Zhone
John Dobosz, 02.23.05, 2:23 PM ET
Matt Ragas and Bill Martin, co-editors of FindProfit, recommend buying shares of Zhone Technologies.
The Oakland, Calif.-based company designs and markets communications equipment that allows network operators to deliver voice, video and data. For the year ended December 31, 2004, revenues were up 17% to $97.2 million, while Zhone's (nasdaq: ZHNE - news - people ) net loss increased by 19% to $35.6 million. Zhone's shares are down 35% in the past 12 months, but 40% higher than their 52-week low of $1.92 on Jan. 26. Based on Tuesday's close of $2.70, Zhone trades for 2.85 times sales, 1.1 times book value and 67 times expected 2005 earnings. The company's market capitalization is $255 million.
Lately, Ragas and Martin are impressed by the brisk pace at which institutional investors are buying Zhone shares, particularly the additional purchases made in recent weeks by Richard Kramlich of venture capital firm New Enterprise Associates. Also, the company turned cash flow (from operations) positive in the fourth quarter of 2004. Ragas and Martin say that 2005 revenue expectations of $119.5 million "could prove to be low if Zhone's recent momentum in its Single Line Multi Service and Optical Transport product lines accelerates as the year progresses."
Zhone was founded by Mory Ejabat, the same person who founded Ascend Communications and sold the networker to Lucent (nyse: LU - news - people ) in 1999. Zhone gained its public company status from a 2003 merger with networking hardware maker Tellium, and now competes against networking industry leader Cisco Systems (nasdaq: CSCO - news - people ), as well as Nortel Networks (nyse: NT - news - people ) and ADC Telecommunications (nasdaq: ADCT - news - people ).
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"This certainly isn't a dirt cheap stock, and Zhone doesn't have a track record of knocking the lights out execution-wise, but we think our downside risk in the stock at this valuation is still fairly modest, while the upside potential over the next 12 to 18 months could be significant," says Ragas. "The company looks to be close to hitting a profitability inflection point, which should lead to increased Wall Street interest in the name, particularly given that Zhone has products in growth markets that investors are interested in, a veteran management team, and strong insider buying conviction."
With average daily volume over the past three months of 577,000 shares, Zhone shares are decently liquid, but Ragas cautions investors to "use patience and limit orders if they decide to accumulate a position," and he favors doing so on weakness. "This represents a multi-quarter investment for us that is best suited to more aggressive and higher risk accounts." |
