Ascend Communications, Inc.
ú The 40% annual growth of remote access users should pressure carriers to purchase more remote access equipment to meet
demand. We are also seeing a situation where the incumbent RBOCs (surprise, surprise) are just now in the early stages of
Internet service rollouts. We expect to see a continuing trend towards buying of next generation RAS (Remote Access Server)
hardware such as the firm's leading-edge TNT platform by existing ISPs looking for higher port density, more sophisticated
security, and management software. Ascend and 3COM, the two clear leaders in the remote access space, should be among the
greatest benefactors of these trends.
ú In 1997, the lack of 56K modem standards caused many sales of remote access equipment to be delayed. These modem
standards were finally drafted at the end of 1997. The anticipated consumer pull that some had predicted would put 3Com (US
Robotics) on the top of the 56K squabble didn't happen. Instead, the resulting ISP push (for marketing purposes) to have 56K
capability, while causing Ascend some infamous problems in mid-year 1997, resulted in Ascend becoming the leader in 56K
port sales to ISPs due to the unique marketshare splits between the firm and 3Com.
ú After much effort, Ascend's acquisition of Cascade is proving to be a success. The strong sales of the Cascade ATM line over
the last number of quarters have helped offset some of the sales weakness of other product lines overseas. We believe that
1998 will be a banner year for ATM and that any rebound in the overseas markets will be incrementally positive to our current
sales projections. While Cascade is still getting its legs under it and is facing stiff competition from Newbridge, we believe
there is more than enough market to go around for all concerned - despite some vendor claims to the contrary (it is always a
zero-sum game for vendors).
ú Based on a rough "back-of-a-napkin" F1999 EPS estimate of $1.50, we believe that Ascend should be able to grow at a
sustainable rate of 30%. Using a 1 time growth rate valuation method based upon our 1999 estimate, we believe that Ascend
shares should reach a price target of $45 within the next 12-18 months.
ú Ascend is the leader in the high-end of the ISP RAS market. The firm's TNT is substantially through its teething problems and
has a likely 6 month lead over rival firms. With the firm's only share competition at the high-end coming, in all honesty, from3Com we expect the firm to maintain the lead of the TNT with introduction of next generation and higher port-density cards in
late F1998.
ú Input from clients continues to indicate some strong buying interest in Ascend (despite frustration with the time required for
daily rumor management). Our feeling is that this buying interest is motivated by the firm's strategic position and valuation, is
substantial and is simply looking for a catalyst. If this catalyst takes place, reasonable expectation would see the stock move
and in sizable increments.
Although the networking sector had a tough 1997, primarily due to unanticipated weakness in Asia and greater than expected
European demand for 56Kbps modems on the TNT, we believe that 1998 will prove that networking hardware vendors still have a
long and robust life ahead of them. Ascend's stock was particularly hit as 56K software delays exacerbated lagging sales cycles
overseas. Now, with a "let's keep everyone happy" 56K modem standard being agreed to, order momentum should continue to
pick up for Ascend's suite of remote access products.
Industry sources indicate that the number of remote access users is increasing annually by 40%. In order to keep up with demand,
carriers will need reliable, high-density remote access switches and concentrators to handle the increased capacity. In addition,
these products will need to meet telco standards and offer very high functionality at a low price per port. To date, Ascend's award-winning
MAX TNT has the highest port density of any concentrator in its class. To meet added functionality requirements, Ascend
plans to offer modular add-ons for the TNT over the next couple of quarters until the next generation TNT is available in the
second half of 1998 - with a modest expected sales contribution in late 1998. Ascend remains very competitive in its price per port
and has been able to maintain its leading position in the increasingly competitive remote access space. Although 3COM's
Corebuilder product should prove a solid competitor against the TNT, we believe that the size and growth of this market is large
enough to support solid growth for many players in the space.
Ascend's acquisition of Cascade has proved a success with its strong ATM sales helping to offset some of the weakness felt
overseas. We believe that ATM will have a banner year in 1998 as bandwidth demand increases subsequent to the increase in the
number of online users. Any material sales from the new GX550 ATM switch will be incremental to our current sales projections.
The product was just recently taken out of beta and has already been purchased by Williams Cos. which had recently announced
that it chose the new GX550 ATM switch to equip its entire network. This product was just recently beta tested by Williams and
purportedly "works great right out of the box". In a partial validation of Newbridge Chairman T. Matthews' mandate that cross
connects are not necessarily needed in a pure ATM switched network, Williams will be using the GX550 without cross connects.
At present, the 3 major players in the ATM carrier space are Newbridge Networks, Cisco, and Ascend. Nortel is also a significant
ATM player but with a larger presence in the enterprise space than the carrier backbone at this time. We believe that ATM sales
will take off as demand for bandwidth puts more pressure on carriers to upgrade backbone networks with high-speed, scalable and
flexible switched network backbones.
Valuation Analysis The current "Street" range is very wide, with the high at $2.00 and the low at $0.52. Excluding the highest
and lowest estimate on the Street, consensus comes in at $1.57. We predict that the company will grow at a sustainable rate of
30%. Using a 1 times growth rate valuation method based on a ballpark F1999 EPS estimate of roughly $1.50, we predict that a
$45 price target will be achievable within the next 12-18 months.
Newbridge Networks
ú Problems with Newbridge's UB unit should soon be over as the final steps in the restructuring process are completed.
Already, the company has laid off 200 employees (primarily sales staff) from the unit. We anticipate that the UB
announcement (expected by Feb. 1) will be multi-faceted in the following way:
1. "Transfer" of the firms' older layer 2 UB products/assets to 3COM
2. Gradual migration of the more advanced layer 3 UB/Newbridge LAN products to 3Com over time - to preserve
continuity for the Newbridge LAN installed base customers
3. A range of co-marketing agreements between 3Com and Newbridge regarding the firm's VIVID and 36170 ATM
switching products.
ú The resulting one-time event related to UB and the firm's willingness to "fall on the sword" and cut their losses should
generate some substantial goodwill on the Street in 1998.
ú Although TDM sales continues to be flattish, we believe that growth in ATM product sales will offset this move as TDM
enters its mature market stage. TDM currently represents approximately 45% of Newbridge's total revenue and carries 70-
75% gross margins. While a cash cow, TDM has been staying relatively flat for the last two quarters as WAN packet sales
continue to show double digit sequential growth.
ú The company recently announced that its co-marketing agreement with MCI (MCIC/NASD/$42.69/NR) has been extended
for another two years. The agreement has been in existence for about four years and had previously included onlyNewbridge's TDM equipment. Now, MCI has expanded the agreement to include WAN packet products as well. Last year,
MCI contributed roughly 2% of total revenue, all in TDM sales. Sales of WAN packet gear could help exceed last year's
contribution.
ú Industry sources indicate that Newbridge and 3COM will shortly announce more details regarding their alliance (see earlier
point re: UB). We think that this announcement will describe a formalized co-marketing agreement between the three
companies (Newbridge/Siemens/3COM). Revenue gained through this alliance would be incremental to current sales
projections. Although we do not believe that significant contributions will be made this year, we think that the revenue
potential going into next year will be very high. The ability for Newbridge, Siemens and 3Com to take on larger and/or more
specialized players such as Cisco should not be underestimated.
ú Our current F1999 earnings estimate for Newbridge is $1.63. We predict that the company will grow at a sustainable rate of
40%. Using a 1 times growth rate valuation method based on our F1999 EPS estimate of $1.63, we predict that a US$60-65
price target will be achievable within the next 12 months.
ú We are expecting the firm to announce a number of domestic and large offshore ATM telco contracts for ATM-centric
networks in F1999 - further evidence of the firm's continuing momentum and leadership in the broadband switching arena.
Data Communications Trend Analysis for 1998 We believe that the following subsectors of the data communications group will
have a strong presence in 1998:
ú Broadband switching, frame relay, SONET, and ATM should all experience solid growth in 1998. Among the
companies that should benefit from the growth in this sector are Newbridge, Ascend, Yurie Systems, and 3COM.
ú Remote access companies should have a banner year this year. Growth in this sector should be propelled by the
growth in sub-$1,000 personal computers and the drop in price of 28.8 modems. In addition, the 50% a nnual growth
of Internet users should also provide another impetus for the remote access market as more companies want to take
advantage of the synergies attached to providing online usage to their employees. Beneficiaries of this trend include
Ascend, 3COM, and Shiva Corp. (SHVA/NASD/$10.50/Neutral).
ú The rise in remote access and Internet usage as well as the type and amount of content provided online should
aggravate current bandwidth problems. As a result, companies that address bandwidth issues will benefit from this
critical need which spans both corporate and residential users. We continue to believe that low speed xDSL (e.g.,
HDSL, IDSL) will prevail in the short term. Companies to benefit from this trend in 1998 include PairGain
(PAIR/NASD/$17.00/Outperform) and ADTRAN (ADTN/NASD/$24.00/Neutral). We believe that RA-ADSL
(rate-adaptive ADSL) will be the ultimate winner long-term as costs and standards are set.
ú Growth in remote access and online usage should also drive the need for better security. As a result, we believe that
network security will become a mandatory checklist requirement in the near future. These solutions will need to be
comprehensive (i.e., an end-to-end solution), robust, and virtually transparent to the end-user. We believe that
demand for virtual private networks (VPNs) and electronic commerce applications will further enhance growth in the
network security space (and vice versa). Companies that are able to adapt quickly to the changing requirements (e.g.,
security must become more robust as computer processing speeds increase and must be able to conform to changing
standards requirements) should be able to succeed in the space. Beneficiaries of the growth in network security
include Security Dynamics (SDTI/NASD/$36.88/Buy), Network Associates, Check Point Software, Axent/Raptor,
and others.
ú As investors become more aware of the importance of OSS (Operations Support Systems), we believe that valuations
will rise accordingly. We continue to believe that there will be on-going M&A activity in the space as more
companies attempt to build critical mass. We believe that CrossKeys (CKEYF/NASD/$13.50/Buy) could be among
the immediate beneficiaries of this trend. |
