This is from one of Canada's biggest Brokerage House's, their report on Newbridge Networks:
DailyLetter ADDENDUM
Wednesday, February 4, 1998
RECOMMENDATIONS
* REDUCE/SHORT TERM Newbridge Networks-company currently over troubled
waters (Parhar, Grossner)
NEWS
* Newbridge Networks (NNC : TSE : $28.75, NN : NYSE : $19.94 : Issued
174.7M)
Newbridge shocked the markets by reporting that Q3/f98 revenues will
be C$360M (versus our expectations of C$435M) and EPS from continuing
operations, excluding one time gains/losses of C$0.10 (versus our
expectations of $0.36). The reasons for the drastic shortfall include
a dramatic fall of the sale of TDM (from $192 M in Q2/f98 to $133M in
Q3/f98), a mature but highly profitable product line with gross profit
margins near the 70% level and further sales decline in the former UB
networks products (from $33M in Q2/f98 to $29M in Q3/f98).
Why such a fast decline in profitability?
It is fair that to say that we were caught off guard (along with the
majority of the other analysts) on the extent of the current problems
in TDM. In the past, the market was very sensitive to a slowdown in
TDM, but the warnings have previously proven false. It now appears
that the TDM slowdown has arrived, and at a much faster rate than
earlier anticipated. With the benefit of hindsight, it appears that
management has focused a significant amount of attention on the failed
UB strategy. The growth the Company expected did not arrive (refer to
chart of quarterly UB performance).
Summary
We are currently forecasting 1998 f.d. EPS of C$0.89 (down from our
previous $1.50!) on revenues of C$1.6B, followed by 1999 f.d. EPS of
C$1.25 (down from C$2.25!) on revenues of C$1.8B. Given the reduced
expectations, we are lowering our target price ratios to reflect our
extreme disappointment in Newbridge performance. Our current price
target is C$26, using a P/E of 21X on f99 earnings of C$1.25 f.d.
Further share price weakness seen short term / medium term
We believe that even at the current 52 week low share price of
C$28.75, Newbridge will trade down below $25.00 in the next few months.
Thus, we temporarily rate the shares a short term REDUCE. We will
quickly revisit our recommendation once we see further price weakness
or in light of any significant contract/product announcements (which
Newbridge indicated are coming in the next few quarters). Over a
longer term perspective, we believe that a buying opportunity may
become apparent once the market has fully discounted the current
disappointing performance, and we will advise accordingly.
The Bad News: Further risks still apparent
1? TDM market falling fast (bad for top line, worse for bottom line).
In Q3/f98, TDM revenues fell to $132M (versus $192M in Q2/f98, a
decline of 31%). We are currently projecting TDM revenues to decline
by 20% in f99 (versus our earlier projections of marginal declines).
This 20% decline in revenue is further exaggerated in the bottom
line, as TDM is the current "cash cow" of Newbridge, generating gross
margins in excess of 71%. There is no real hope that TDM, a mature
technology, will ever be in a growth mode, given advances in
competitive technology. We were surprised at the rate of decline of
TDM.
2? Competitive pricing pressure expected from current competitors
CISCO, Nortel, and soon, LUCENT). As the new entrants (Cisco and
Lucent) begin to make an entry into the traditional "carrier space" of
Newbridge in high speed ATM, we believe that pricing pressure may
begin to be felt in the future growth prospects of Newbridge. Lucent
and Nortel are "refocusing" in this area.
The recent success of Cisco with US West is especially alarming,
considering that Cisco, which is a extremely strong in the LAN market
space, appears to have set its sights on the WAN market space. This
is a sharp contrast to last year, when it was suggested that Newbridge
would invade the LAN space with the UB Networks acquisition. With
Cisco's announcement, we see the first confirmation that
non-traditional competitors will be able to invade NNC's WAN space,
albeit at the lower end at the moment.
3? Lack of diversified product portfolio (i.e. ATM bet) In the area
of global telecommunications companies vying for global dominance (i.e.
Lucent, Ericsson, Siemems, Motorola, Nortel, and Cisco), a diversified
product portfolio provides a "balance" in an area of accelerating
change in technology. As an example, Lucent is strong in Public
Carrier Network (including WDM), Enterprise Systems, and
Microelectronics (including optoelectronics), while Nortel's portfolio
includes Public Carrier Networks, Enterprise, Wireless, and Broadband.
>From a end-customer perspective, these companies are trying to provide
a "one-stop shopping experience" (or "complete customer solutions"),
which is an effective selling tool for larger companies when trying to
compete with smaller, more nimble companies that may have a technology
edge (such as Newbridge with the current generation of core ATM
switches). As well, the larger companies (Lucent, for example) have
started a new tactic in the high stakes technology arena by
pre-announcing" the launch of a product, before the product is out of
prototype phase testing. The obvious goal of the tactic is to attempt
to stall those customers who might have been tempted to purchase a
currently available product from a competing company. The threat of a
competitive product from a large market play will likely cause
uncertainty in the minds of the purchasing manager.
Given our current understanding of the competitive strengths of ATM,
SONET, IP and optical networking (WDM), we believe that NNC must
diversify out of a pure ATM play. The affiliates are a "hidden
asset", and Newbridge may want to incorporate some of the higher
growth potential/strategic products companies into Newbridge (for
example, the Cambrian on the MAN WDM product portfolio).
Possible Good News
Share Buyback
Newbridge indicated that it may consider a share buyback program at
the February board meeting. While this may be considered a positive
step by some, we are vary of increasing our fundamental ratings on a
company just because of a share buyback. However, it may be prudent
to consider repricing key line employee options (i.e. non-management)
in order to retain the engineering talent.
Will Siemens step in to buy NNC?
This is pure speculation, even though 1) Siemens is Newbridge's
largest customer, 2) the companies have shared research and
development on leading edge ATM (36170 and 36190) and 3) the price
required to buy NNC has fallen dramatically in the last two months.
With Terry Matthew's controlling 23% of NNC, a takeover will probably
require his support, and we have no insight into whether Terry wants
to "sell out" at this point of the game.
Large ATM contracts to be announced
Newbridge indicated that several large ATM contacts (global) are
expected to be announced in the next quarter. This should provide
some "boost" to the stock.
Previously announced contracts will show "real revenue soon"
We need to see evidence of the revenue growth (not just design wins)
from the large contracts recently announced (i.e. MCI/BT). Newbridge
indicated in the conference call that they are expecting revenues to
pick up in the current quarter (i.e. Q4/f98).
New Product Potential
We believe that possible new product strategies from Newbridge will
include ADSL and LMCS interfaces, along with SONET/IP products.
Conclusion
At current price levels and the current competitive environment, we
would attempt to pick up NNC below C$25.00. The upside will be
realized when Newbridge delivers on its promises of profitable ATM
revenue growth, and shows profitable new product potential.
Gurinder Parhar, P.Eng. (416) 869-3765
Murray Grossner, CFA (416) 869-3290
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