Its interesting to see the brokerages perspective in the following from briefing.com and from that see why more of them are not piling into MRVC & are blind to how MRVC is different from other small co.'s.
Updated 03/23/98
StreetBeat is designed to provide you with additional insights on the market from recognized financial experts on
(and off) Wall Street. Please note that the views and opinions expressed by the panelists below are not
necessarily those of Briefing.com.
This week's topic: Networking Companies
Panelists
Peter Lieu, Senior Vice President, Research at Adams Harkness Hill.
Christin Armacost, Networking Analyst at EVEREN Securities.
Q&A
Briefing: Which areas of the networking industry hold the most room for growth and which
companies are best positioned to capitalize on that growth?
Peter Lieu: Although investors tend to group these companies as one, it is important to remember that
networking is heterogeneous and one needs to consider the sub-groups. Having said that, though, the networking
group is reminiscent of the computer industry about 15 years ago, with Cisco as the clear dominant player. Bay
has attempted to challenge Cisco in routers but it has suffered dislocations in merging its predecessors
companies (Synoptics and Wellfleet) and lost market share to Cisco .
In terms of growth, switches - high, medium, and low-end - offer significant potential for this group, with low-end
switches offering the best growth potential. Bay holds the lion's share of sales in low-end switches with about a
40% market share. 3Com and Cisco have recently come into this market and pricing has become vicious.
Routers are more difficult to produce than switches and very few companies have router capacity. Cisco is the
clear leader in routers with Ascend following well behind. The router switch market, which represents a challenge
to the router market, is emerging as another significant growth area. 3Com and Bay are out in front with their
products and it is expected that Cisco will come into this area as well. The remote access area was strong
through last year but consolidation among ISPs has slowed growth and Ascend had disappointing growth
because of this and competitive displacements.
Christin Armacost: Holding the most room for growth are Local Area Network (LAN) and Wide Area Network
(WAN) switch routers along with remote access. Each of these areas is growing in excess of 20% which is a
noteworthy development in this very competitive marketplace. Given the rapidly changing environment in the
networking industry, it would be more germane to say that those companies which currently stand the best
chance of success in these respective markets are Ascend, Cisco, and to a lesser extent, Newbridge Networks,
3Com, and Northern Telecom. When considering the remote access market, it is a very close race between
Ascend, 3Com, and Cisco. Ascend and 3Com lost share in 1997 while Cisco went from nothing to mid-teens in
market share, and potentially, could emerge as the leader in absolute dollars for the quarter. With WAN switches,
Newbridge Networks, Ascend, Cisco, and Northern Telecom are all fairly close.
Briefing: Bay Networks and Cabletron Systems warned that earnings would fall short of
expectations due to weak demand and margin pressures. Do you think that these are
isolated cases or is there an industry-wide demand problem and if so, what are the
contributing factors?
Peter Lieu: I think that these are not only isolated cases, but that the factors contributing to the warnings for CS
and BAY are very different. CS is under extraordinary management transition. They have a new CEO, Don Reed,
a new distribution model, and are moving toward new product lines. Cisco and CS used to be marketing partners,
but Cisco has now become a direct competitor. We see CS slipping very badly in the near-term. The Yago
Systems acquisition may prove to be a positive step in getting CS back in the router ball game, but it remains to
be seen if CS can right the ship.
Bay has gained market share in the last three quarters against peer companies. They have been victimized by
product transition pressures and a weak macro environment (Asia and competition in low-end switches). Demand
appears to have softened because of product cycle transition issues. Bay announced that they have new
products in the works and customers are holding orders until these products are available.
Christin Armacost: I would agree that it is a widespread issue as industry growth is slowing dramatically.
Consider that from 1993-1997, the industry was growing 30%-50%. In 1998, we're expecting growth of only 15%
due to reduced average selling prices, and an already saturated market. Also worth noting is that since January
1, 1997, six of the seven largest networking companies have reported an earnings shortfall at least once. Cisco
remains the only company not to have disappointed, yet it stands to reason that it can't be isolated forever from
the obvious, and significant, product transition and pricing pressure trends that are hitting the industry.
The whole issue of product transition started with the customer, namely corporations which view their corporate
networks as being absolutely critical to the way they operate. As such, they are reducing the number of their
suppliers, and moving more toward strategic suppliers. This shift has fostered a wave of consolidation in the
industry as networkers endeavor to become single-solution providers. While making this change, all vendors find
themselves exposed to some product that has reached the end of its life cycle, and this is one of three,
contributing factors to the competitive pressure gripping the industry. The second is that smaller companies are
either being acquired, or being forced out of business, since they can't compete with the larger players in terms
of R&D spending, product breadth, and distribution methods. Finally, the myriad of technology available to
customers is just plain confusing, and is causing customers to delay purchasing decisions. All of these factors are
forcing a smaller number of vendors to compete for customers, and subsequently, many of them are occasionally
lowering prices in an irrational manner to maintain a declining market share. Prices, which normally fall 15%-25%
a year, are now down 35%-40%. At this rate, there is no doubt that only the strong will survive.
Briefing: How will the increasing competition from telecom equipment makers and
semiconductor companies change the competitive landscape?
Peter Lieu: There is no doubt that the telcos will continue to get into the business that has traditionally belonged
to the networkers. Northern Telecom, announced just yesterday that it had acquired Aptis Communications which
will put them in competition with Bay, 3Com, Shiva, and others in the remote access space. Semiconductor
companies have been getting into the networking business at the low-end as it is in their best interest to expand
the communications capability of PCs. Intel, for example, is making NIC cards and low-end switches. Its
value-added is in networking switches where Intel brings the formidable ASIC Design capability. It is interesting
that we have not seen Intel do as much damage to 3Com as we would have expected given that Intel has been in
this business for roughly five years.
Christin Armacost: The telecom equipment makers are a serious threat because they are aggressively
re-directing employees and resources to develop data networking solutions since this area has a faster growth
rate and higher margins than voice technology. The stiffest competiton will come from Lucent, Ericsson, Alcatel,
and Northern Telecom. Since the start of this year, all of these companies, with the exception of Lucent, have
made product announcements, or acquisitions, aimed at winning business in the data networking market. As for
Lucent, it has always had some involvement with data networking since its spinoff from AT&T.
In contrast, the presence of semiconductor companies is not exactly new as they have been partnering with
networkers for a while. Thus, they present more of an opportunity than a threat, because more features can be
included on silicon which, in turn, has the potential to offset to a certain degree some of the price erosion on the
products. The use of silicon, and continued silicon enhancements, is an ongoing part of the networking vendors'
existing relationship with the semiconductor companies.
Briefing: Which stocks are you recommending and/or avoiding?
Peter Lieu: We just took Shiva (SHVA) off the Buy list because of the Northern Telecom(NT)/Aptis acquisition.
We were looking for Shiva's relationship with NT to improve, but the acquisition places any improvements in
jeopardy. We do not think that Bay will be the only networker to disappointment in earnings and because the
market tends to overreact to bad news creating buying opportunities, we are waiting for those buying
opportunities.
Christin Armacost: The four companies I cover include Shiva, 3Com, Cisco, and Ascend. Of the four, Ascend
(ASND) is the only stock on which a BUY rating has been issued. I believe the company has weathered the worst
of its product and earnings troubles. They have made good changes internally with management and with their
product transition problems. As such, I feel they have re-positioned themselves to regain market share lost in the
second half of 1997.
3Com (COMS) is rated NEUTRAL, because I think its earnings estimates are too high, and its inventory transition
efforts will take a lot longer than most analysts are expecting. Shiva (SHVA) is also at a NEUTRAL rating. While
its business strategy is improving, it is still too early to call it a success. Finally, I have a NEUTRAL rating on
Cisco (CSCO) based on valuation, and the fact that widespread product transition and pricing pressure in the
industry is just too great to overlook-- even for one of the best managed companies in the industry. |
