Finding the best buys in the bandwidth supply chain
Marketwatch - February 21, 2007 12:01 AM ET
NEW YORK (MarketWatch) -- I've written a number of pieces about the companies that control the ever rising amount of data zooming around the internet, specifically Akamai Technologies Inc. (AKAM) and F5 Networks Inc. (FFIV) as they are the critical traffic cops at the most crowded junctures of the networks.
At some point though, no level of sophisticated software can make up for a potential lack of bandwidth, be it in the core, the edge, or the access portion of the Web. Carriers have not had to deal with such a problem so far because the overspending of the bubble years had created overcapacity as far as the eye could see. But things just might be beginning to change, and if or once they do, it may resurrect enthusiasm for companies that have languished at the bottom of the network barrel for years.
Triggers for this potential change
First is the rapid adoption of Fiber To The Premises (FTTP), thanks to the massive marketing push of the major carriers, Verizon Communications (VZ), Bell South and AT&T Inc. (T). The fact that Verizon is beginning to fade its marketing of DSL suggests that FTTP has reached a point of no return, and will ultimately become the pipe of choice together with cable. If you have a chance to try out an FTTP service, do it: it is the equivalent of going from 480 to 1080 High Def. It is really cool.
Second, much as iTunes changed the way music is delivered, something along the same lines is going to change the way high-quality commercial video is delivered, and when those video services are in full swing, their bandwidth demand will swamp what we are seeing right now.
Third, while there is still plenty of dark fiber at the very core of the network, all indications are that "metro networks," the large systems that reside between the core and the edge, are beginning to get crowded.
Given the current environment in the financial markets, chances are that once one or two companies in the space start talking up their business prospects, speculation will spread across all companies like wildfire. Let's be honest, the Applied Micro Circuit Corps. (AMCC) of the world are still the companies that people are itching to buy, dreaming to sell them out in the triple digits. However, away from the dreams and temporary "BUYBUYBUY" induced price spikes, only a few companies will show bottom line results that will justifiably move the stock.
The obvious question is ho to find them.
Finding the right stocks
I am using two criteria: First and most difficult, I am looking for companies highly concentrated in the area that should benefit the most from the coming network upgrades. Second, I am being relatively stingy with what I am willing to pay, because if I overpay and the fundies don't pan out, it will be mighty painful, and there likely won't be a second chance for a long while. More diversified companies like Tellabs Inc.(TLAB), which I own only because it seems relatively cheap, may well benefit in some product lines only to get hurt in others.
In order of risk adjusted preference, my faves are: Juniper Networks Inc. (JNPR), MRV Communications Inc. (MRVC), Ciena Corp. (CIEN) and Avici Systems Inc. (AVCI).
There's no question that Juniper is in a dogfight with Cisco Systems Inc.(CSCO), but it's perhaps as close as I can get to a pure play in the space I want to be in. Once the network upgrades arrive Juniper will get its share, and my sense is that there aren't too many positive surprises built into the stock. Meanwhile the balance sheet provides a decent cushion should things not pan out.
MRV was a much better buy in the low $3s, when our friends at M.S. Howells & Co. suggested I revisit it. I've being following MR for a long time because of its products at the end-user side of the FTTP play. What I ignored is that it also has a meaningful presence in the "right" area of the network. There's one major catch with MRV: It sits way down the supply line. It supplies company ABC, which in turn supplies company DEF, which in turn ... This means that the pricing pressures exerted by the carriers on their first-tier suppliers get magnified as orders finally flow down to MRV. If MRV actually managed to turn revenues into profits, the stock could catch a really sweet ride.
I like where Ciena sits. Its balance sheet is in good shape, and the company is finally making money again. By all accounts its 4200 product is a great Metro Area Network tool. But its problem is that it still has the ball-and-chain drag of the "network backbone" products. Just thinking out loud, could the invisible catalyst come from the international markets? Unlike its past history, Ciena might end up being the winning "turtle" more so than the hare.
Last is Avici. This is more an open-ended, call-option play than an investment. Right now Avici has only one customer, AT&T, to which it sells its hardware solution. Confident as it may be that AT&T will stick around long enough for Avici to reinvent itself, the single revenue source poses huge risks. The light at the end of the tunnel - assuming it is not a train - consists of a new software-based traffic management solution under development. This will bring Avici much closer to competing with the likes of F5 Networks, but the technology behind this new product, from what I understand of it, is very intriguing. If it pans out, Avici revenues and profits could ramp very quickly, and-or Avici could become takeover bait. If you are thinking that this sounds like a roll of the dice, you are absolutely correct, and that's why even after Thursday's 15% move, Avici still trades at less than two time net cash, and one time projected 2007 sales.
Again, please keep in mind that these "stories" are predicated on what I perceive to be a coming boost in spending for certain areas of the networks which to date have been left for dead. This process is certainly not going to be of a "secular" nature, but it should play out over several quarters, not a couple of months. Monitor closely the broad news regarding carriers' capex spending, and if you don't "see" the story, don't force it.
Minyanville's Fil Zucchi is the founder and manager of Zebra Investment Advisors LLC, a Virginia registered investment adviser; and of Zebra Fund LLC, a long-short hedge fund. |
