Trial by Fire
By Will Swarts Published: September 27, 2006
Foundry Networks (FDRY)
Share price as of Tuesday's close: $12.54
Share price now: $13.37
Percent change: 6.6%
Volume: 8.3 million shares, daily average 2.5 million
The News
Shares of Foundry Networks (FDRY: 13.37, +0.83, +6.6%) threw off sparks Wednesday, closing almost 7% higher thanks to a key stock upgrade from Robert W. Baird. Analyst Kenneth Muth lifted his rating to Outperform from Neutral on expectations the network-equipment maker would benefit from the information-technology spending boom far more than it would suffer for its role in the ongoing options backdating scandal.
"We believe data networking spending trends can remain favorable within the U.S. Enterprise segment over the next 12 to 24 months," wrote Muth, who also boosted his price target to $15 from $11. "Foundry is about one year into its product upgrade cycle and we believe is executing well with these new products in gaining mind share."
On Friday, the Santa Clara, Calif., company announced it would revise financial results as far back as six years after an internal review turned up errors in how it accounted for stock-option grants to employees. Foundry notified investors of its options issues earlier this summer. More than 100 companies are conducting internal reviews or facing more formal scrutiny from regulators over the timing and pricing of employee stock options.
That casts a haze over the company's quarterly and full-year results, though Wall Street analysts are calling for double-digit jumps in profits and revenues. Earnings tracker Thomson First Call's estimates for the third quarter call for earnings of 12 cents a share, an 11% increase from the year-ago period. Full-year forecasts see earnings of 48 cents a share, up 23% from 2005, on revenues of $458 million. That's a 13% increase from last year's sales of $404 million.
Foundry's stock had been down 12% year-to-date before the Baird upgrade, lagging competitor F5 Networks (FFIV: 53.61, -0.94, -1.7%), which was down 8% for the same period, but performing better than Juniper Networks (JNPR: 17.29, +0.14, +0.8%), whose shares were down 24%. Of course, these second-tier players in the networking equipment sector are all scrapping in the shadow of Cisco Systems (CSCO: 23.35, -0.15, -0.6%), whose shares are up a robust 36% for the year.
The Analysis
Sure, Foundry's been cast as a corporate miscreant, but its alleged options misdeeds are a matter of degree, and investors are starting to differentiate between companies with procedural issues and those with more serious problems. In the context of both the widening scandal and the broader market for its wares — mostly networking gear like Ethernet switches and secure socket layer virtual private networks — Foundry won't crack any time soon.
"Foundry completely refreshed its product portfolio in the past year, with benefits to continue over the next couple years," wrote Bill Choi, an analyst with Jefferies & Co., in a Monday note initiating coverage of the company with a Buy rating. "Success in re-entering the carrier routing space remains to be seen, but timing is good and investor expectations are low. Options accounting issues remain a risk but present [a] potential buying opportunity."
Jim Kelleher, an Argus Research analyst, says Foundry's lack of debt will likely help it avoid more serious technical infractions as it overhauls its books, because any issues it faces won't affect stockholder equity levels.
"I think the presumption is that rather than treat all the backdating companies as one big inkblot, one big stain on humanity, there's a move to separate the ones that have major restructurings coming from those that don't," he says. "There's maybe a move where some investors are beginning to sort them out and say some are terrible risks and some are lesser risks."
Muth says his analysis of Foundry's potential problems puts the company in better shape than Juniper or F5, although its woes aren't going to provide a whole lot of definitive numbers for investors in the near term.
"Reading between lines of their press release, they're saying, 'We're not gong to have financials for Q3,'" he says. "But investors are caring less about options this quarter than last quarter, when it was really shocking and all those stocks got haircuts right away. They're much more concerned about fundamentals and what's happening in the marketplace."
The Bottom Line
And what's happening there is pretty good. Foundry's got a reputation for making quality equipment that costs 30% to 40% less than Cisco's, always an advantage in a price-sensitive industry, Muth wrote.
The company provides the switching backbone for Avaya (AV: 11.85, +0.12, +1.0%), the No. 2 domestic maker and manager of communications networks, a partnership that's been a boon to sales, according to Muth. It also has a "respectable share" of high-margin federal government IT spending, though Muth cautions that's a little harder to track than some other customer segments because spending patterns can change with new budget legislation.
"Enterprise spending seems to be healthy across the board," he says. "It's not just one company performing well. We think it's more of an industry macro situation right now."
But the tech-upgrade cycle shrinks constantly — the Y2K upgrades of 2000 were on a six- to seven-year cycle, and that's now compressed to three to four years — which helps a company like Foundry that can bring new products to market quickly and cheaply.
Assuming it can avoid an options meltdown, it looks like this stock may break the mold. |
