Buy Acme Packet; It's Mellanox In Reverse
January 31, 2013 | 1 commentby: Akram's Razor | about: APKT, includes: JNPR, RVBD, T, VZ
Disclosure: I am long APKT. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. (More...)
"The little reed, bending to the force of the wind, soon stood upright again when the storm had passed over." - Aesop
Those of you who have followed my writings on Mellanox ( MLNX) understand that hardware component tech stocks require a good deal of cycle timing. If you catch an upgrade cycle before it happens, you can do very well, but as that often requires a good deal of luck, most of my experience in the space comes from shorting these names when I think a cycle has peaked. This is because identifying such a stock once its share price has gone parabolic and the media and sell side have fallen in love with it is naturally a lot easier than digging it up before a cycle starts; ultra bullish analysts, momentum traders, and CNBC don't show up until something already has legs. But every now and then the stars align and something you might have been shorting actually presents itself as a long.
When this happens you have an edge on the market because you already know the business model and story inside out. And this is how Acme Packet ( APKT) has made its way back onto my radar. Back in 2011 when the stock was a market darling, I was shorting the name under the belief that the secular tailwind driving demand for their Session Border Controllers was not going to be nearly as strong as the market expected and that competition in the space would heat up. Combining this core thesis with a nearly $5 billion market cap tech infrastructure play made for an appealing investment despite the fact that I actually liked the long-term prospects of the company, and unlike Mellanox, had few problems with the management team. When I took my position and wrote up the idea, the stock was trading at $74 a share and the company was at the back end of a seemingly endless stretch of good news.
That all ended pretty fast, and for the better part of the last two years and spanning six conference calls, Acme Packet has been hunkering down and weathering a growth storm. Verizon ( VZ), one of its largest customers, which had promised initial Voice Over LTE by as early as late 2011, has repeatedly pushed back its roll out. The same story applies to the rest of the Tier 1 carriers, which Acme Packet's growth story is heavily dependent on. Everyone of the past several conference calls has focused on the weakness in North American carrier capex spending and the general slow progress toward VoLTE adoption. APKT has partially navigated this storm by focusing on SIP trunking demand from enterprise customers, but even that hit a snag in the last couple of quarters as the large enterprises that APKT dominates slowed down a bit and the growth in the space shifted to smaller and mid-size enterprises in which Cisco ( CSCO) has a much stronger position. Considering these headwinds, APKT management has had to focus on maintaining a best-in-class product, expanding its sales reach, and winning key architectural designs from customers that can be cashed in when the next cycle finally begins. Based on my research, it would seem that day is fast approaching...
The VoLTE Clouds are Starting to Clear
The most significant driver of APKT's growth story is carrier demand for VoLTE network build out. And as far as this goes, Verizon has been a thorn in the bulls' hide over the past two years as it continually failed to deliver on its promises with respect to VoLte rollout. This was something that I was keyed in on from the short side two years ago, but now I am taking the other side of the trade. Verizon VoLTE will be available to some subscribers by the back end half of this year. I think with MetroPCS in the space, several rollouts globally over the past few months, and AT&T looking like it will be offering HD Voice services in August, there is no longer a reason to doubt that Verizon will deliver. And for those doubting Verizon's CTO, I'd suggest taking a look at this job posting.
VoLTE Engineer Verizon Wireless- This position will be responsible for the designs, deployment, integration, and upkeep of the VoLTE platforms in five NECs throughout the country......
While job postings might not be where you'd expect an investor to go looking for evidence to support a thesis, I have in the past found that mining job boards for information when it comes to 'upgrade cycles' is a good place to start because adopting new technologies on a large scale requires hiring engineers/project managers/ and product specialists. When I did this mining in 2011 I found nothing, this time around that is clearly not the case. I have come across several postings at major tier 1 carriers related to VoLTE infrastructure rollout and product/marketing for VoLTE services. So if Verizon is going to have live VoLTE network before the year is out Acme Packet should be seeing revenue in the nine-month window before launch, and management should have much better visibility and confidence coming into the year.
But while my attention has been focused on Verizon, I think what is even more interesting is AT&T ( T). Verizon's chief competitor was not slated to enter the VoLTE mix until mid 2014, but that now no longer seems to be the case. According to the reps at the AT&T stand at CES, HD Voice services are coming in August. If that is the case, then AT&T should be deploying gear now and testing its network in the front half of this year, which would be a nice boost for APKT. In either case, it would appear clear that revenue related to VoLTE rollout will finally be coming through from the tier 1 carriers in 2013 and will carry into 2014. What was a headwind is now clearly a tailwind. Add in the fact that tier 1 service providers are accelerating the replacement of TDM interconnects with IP, the secular shift in the enterprise toward SIP trunking, and APKT's gains in diameter signaling controlling market over the past quarter and you have to like the demand environment over the next 18 months.
So how does this impact the stock and how do I see this playing out from an investing standpoint?
The first thing I'd focus on here is that this is a company whose management has spent the last six quarters talking about constrained capex spending. On the upcoming conference call expect that tone to shift to something more positive. If you want to dumb down investing in tech, that is probably one of the most important things you can look for as far as an immediate stock driver. And in my opinion this is more important than the guidance because I am expecting this management team to be conservative as it aims to leverage this upgrade cycle to deliver a steady stream of beat and raises over the next several quarters.
The second thing I'd focus on here is the street. APKT is forecast to deliver 47cents in earnings for 2012 and 55 cents in 2013 on roughly 8%-10% expected revenue growth from the street. I think 2013/2014 estimates for APKT right now will prove to be way too low. There is good EPS leverage in this business model, which will kick in once revenue growth ramps. Once the sell-side gets a hint of increasing management confidence, estimates will start to rise, and upgrades will follow.
The third thing I'd focus on is the market and the way it prices these stocks. Growth stocks, and especially hardware component tech plays, are the best examples of non-linear pricing in the stock market. At the first sign of a turn, the market will start to extrapolate growth going forward several quarters if not years out. As an investor, you want to be in before that starts to happen, as rising expectations will become a headache down the road. Catching a cycle early on gives you the benefit of being long on optimism and putting you in the position to cash in significant gains without having to wait for actual results to come in as expected.
The fourth and final thing I'd focus on is that for the most part Acme Packet has performed in-line with other networking names like Juniper ( JNPR), Riverbed ( RVBD), and Cisco over the past six months. So, the whole space reflating APKT's recent rally should not dissuade someone from being long at these levels. Personally, I see the shares trading to the $30 range in the front half of the year, and I also like the possibility of APKT being acquired by a bigger networking player supporting the share price over the next 12 months.
Conclusion: This company should see nice fundamental business model support over the next 18 months. Taking that into account and considering how challenging the past 18 months have been, this should work out nicely for any investor in the stock at these levels. Personally, I recommend playing this by physically buying shares and also picking up some late spring/early summer out of the money calls on the stock. |
