DLJ ****** DONALDSON, LUFKIN & JENRETTE ****** DLJ
April 17, 1998 Stephen G. Koffler (212) 892-4203
Peter Giglio (212) 892-8946
BAY NETWORKS (BAY: $24) #
Missed Preannounced Number. Guidance lowered. Revenues Down Across
all Product Lines. Downgrading To Market Performance.
Range: Earnings Per Share 1998 vs 1997 % Chg
40-15 Old New P/E Ratios F1QA $0.23 vs 0.25 -8%
(FY:June) 1999E $1.20 $0.80 30.0 F2QA 0.27 vs 0.10 +170%
1998E 0.83 0.64 37.5 F3QA 0.04 vs 0.10 -60%
1997A 0.60 40.0 F4QE 0.10 vs 0.15 -33%
Yield: % Market Cap.: $5.4 Billion 5-Yr. Growth Rate: 15%
Dividend: $ Avg. Trading Vol.(000): 2300 Book Value: $6.65
RATING: Market Perf. Change: Down From Buy 12-Mo. Target: $
Key Points.
" We are downgrading the shares of Bay Networks from Buy to Market
Performance following the further revenue and earnings disappointment. The
company reported results for its Q3F98 that were far below the numbers that the
company pre-announced on March 15th. There appears to have been no meaningful
progress in the company's revenue composition . Hubs and routers still account
for 50% of revenue.
" Numbers will come way down. Based on recent performance, an unfavorable
product mix and company guidance, we don't see Calendar 1999 at levels much
above $1.00. Revenue will not reach December 1997 levels until December of 1998.
Increased operating expenses will act as an overhang on the category and slow an
EPS rebound.
" When Bay pre-announced the quarter, it appeared that it would be a one time
event. Instead, the company missed the pre-announced numbers and is now
reducing guidance going forward.
" Based on the very disappointing decline in switching, we think that market
share gains by Cisco at the low-end are a major cause for the second
disappointment and reduced guidance.
" There may be some downside protection from take-out speculation . We think
as an acquisition candidate in the mid-high 20s, although we don't think that
anything is imminent.
" We would be interested in the stock in the low-mid teens as that would
reflect low valuation and those depressed valuations more adequately reflect the
lingering product transitions.
No meaningful progress in the product transition. Revenue numbers came down
across the board, including switching. This points to continued heavy exposure
to hubs and routers, which still account for half of the business. Hubs will
continue to decline, with the market. We believe that modular hubs took the
greatest hit and there still is a way to go. The router category is subject to
further declines based on market factors and the product transition involving
the Accelar routing switch.
Revenue and Earnings were down big on a sequential basis. Revenue came in at
$547 million , with EPS at $0.04. This was both below prior consensus
expectations and the March 15th pre-announced numbers. The company indicated
that causes for the miss included longer sales cycles and capacity constraints
for the Accelar Gigabit routing switch, price reductions in low-end switching
products, a decline in shared media hubs and a general decline in demand. North
America came in at 63% and International was 37%. Gross margin for the quarter
was a disappointing 46.8%. Declining volumes, along with price reductions and
price protection for the channel and an unfavorable product mix, hit gross
margins for 500 basis points. This presents an obstacle for Bay going forward.
Margins should improve for the June quarter, primarily based on limited price
protection and some volume increase. However Bay's long term plan for bringing
margins up to the 55% level became a longer term plan. We see margins exiting
Fiscal 1999 at 52%.
Numbers will come way down. Based on recent performance, an unfavorable
product mix and company guidance, we don't see Calendar 1999 at levels much
above $1.00. The current revenue make-up puts the company back four quarters,
with a higher expense base. We do not see revenue reaching December 1997 levels
until December of 1998. In effect, the company lost a year and will have higher
operating expense levels than a year prior. The company has added to headcount
in sales and marketing and embraced a national marketing campaign, seeking to
gain mindshare of CEOs. This can be seen in national newspapers, business
magazines and "executive oriented" television news and business shows. The
sales and marketing line for the March quarter, as well as company guidance,
indicate that this program has been an overhang on expenses and slow the EPS
rebound. Sales and Marketing stayed flat from the prior quarter and guidance is
for this category to go up "only by commission expenses."
Revenue for the June quarter should be up sequentially, based on Gigabit boards
for the modular switching platform and additional models, offset in part by a
decline in hub revenue. June is also a seasonally strong quarter, contrasted
with march which is Bay's seasonally weakest quarter.
When Bay pre-announced the quarter, it appeared that it would be a one time
event. Instead, the company missed the pre-announced numbers and is now
reducing guidance going forward. Based on the very disappointing decline in
switching, we think that market share gains by Cisco at the low-end are a major
cause for the second disappointment and reduced guidance. Cisco only introduced
its 10/100 low-end switching products in January and it appears that Cisco's
pricing action and its grabbing share have had a major impact on Bay's base
revenue.
There may be some downside protection for take-out speculation. We think as
an acquisition candidate in the mid-high 20s, although we don't think that
anything is imminent. The networking industry has been a continued
consolidation candidate internally and now externally. However, we believe that
potential external acquirers are more apt to target companies with concentration
in the wide area and that these would not occur in the near term.
We would be interested in the stock in the low-mid teens as that would reflect
low valuation and those depressed valuations more adequately reflect the
lingering product transitions. The Bay shares bottomed out last year at this
time between $16 and $17. At that time the stock was trading at about 1.6 times
12 months trailing sales. We would see the stock becoming attractive in near
$15, when the stock approaches a 1.5 times 12 months trailing sales valuation. |
