Radisys (RSYS) Postmortem
RSYS was espoused frequently by Mark Brophy, its biggest advocate, as an ideal high-tech investment: high growth, great earnings, top-notch management. "Why would anyone pay a 60 multiple for WIND when RSYS could be purchased for a 20 multiple," he said?
We said, "Because we want sustainable earnings growth. We want a franchise. We want barriers to entry." RSYS has little value without those characteristics, whatever its P/E ratio. There has never been anything about RSYS' hardware business that suggests it was anything but an early entrant in a budding commodity business. Last fall I posted an announcement of a hot board by Motorola containing dual pentiums and just about anything else that might be desired. It was just a matter of time before RSYS began to feel inexorable pricing pressures, causing margins to deteriorate.
The last appeal on this thread to forsake WIND and jump on the RSYS bandwagon was posted on a couple of months ago. Curious, I researched RSYS and did my own analysis of whether or not RSYS was on sale and should be bought. At that time, I discovered that RSYS began suffering from a malaise in the quarter ending Sept 30, 1997, before the Asian Crisis. The malaise took the form of decelerating revenues and earnings, suggestive of pricing pressures.
The problem just got worse in the last quarter of 1997, although RSYS continued to increase revenues and earnings.
I then read the RSYS thread and discovered everyone complaining about the stock price, and beginning mistakenly to blame insider selling, management, the market, or anything else that popped in their heads. The stock price was in a downtrend until December of last year when it entered a prolonged period of sideways trading. I knew the stock either would recuperate and, in time, break out to the upside, or else capitulate and break down, with the odds favoring the latter as the continuation of the trend. Throw in my suspicions about margin pressures, and probable disturbances from the Asian turmoil, and a breakdown was indeed highly likely.
The breakdown began about a week ago when the price dropped into the low thirties. At that point I started shorting the stock. My last short was completed yesterday by early afternoon. That evening, the company warned on earnings for the quarter and the near term. Today the company sugar coated the warning with announcements of design wins and signs of encouragement, which stabilized the stock at a loss of about $8.50, and caused it to slowly rebound to a loss for the day of a mere $6.50. Anticipating the dead cat bounce, I covered my shorts early, thereby retaining the full drop from the warning, and a sizable profit for five days of trading.
There are lots of morals to this story. The most important is that low P/E stocks are rarely cheap when you buy them, for they often get a lot cheaper later on when earnings fall through the floor. This is especially true for Hi Tech stocks. This point has been made over and over on this thread using abstractions about underlying economics; now it is made in concrete trading terms. This is why WIND is such a terrific stock-it never disappoints.
Another moral is that you must always beware companies that are in a commodity business, or a business that may soon become commodity. Signs of commodity business are to be found in recent financial reports (like I found the signs in RSYS's September and December quarters), competitive products entering the market (like the Motorola board) or just by asking the question, "What would be the barriers to my entering this business?" Ironically, Mark may be absolutely correct in claiming that RSYS management is excellent. The problem is that excellence is not enough to make a silk purse our of a commodity business. This is another reason why WIND is such a terrific stock-it has excellent management and it is not a commodity.
The last moral is that shorting stocks is not evil, although I rarely do it. The Short Attack I reported last spring was evil, because, if true, it was an attempt to manipulate the market, which is wrong. On the other hand, speculative shorting makes the market more efficient, by providing a counter weight to excessive optimism about any stock.
Finally, what do we expect for future RSYS price performance? That's another story.
Allen |
