You said top and bottom line both growing at 35% last quarter suggests growth may be slowing, and perhaps WIND is overvalued with P/E of 60. Ramsey Su, in post #39, is wondering when WIND will start making money if Tornado is so good. He also wonders why analystsÆ expect EPS of $.13 when last two quarters were $.15 followed by $.19.
Let me try to explain these mysteries. WINDÆs 35% top line growth was on top of an excellent prior year 4th quarter (in which they made more money than all the other 3 previous quarters combined). Thus 35% growth was admirable. The 35% bottom line growth was reduced because of extraordinary, one-time product and marketing costs associated with the Tornado campaign. Numerous eval kits were sent to interested parties, and extra marketing costs were expended to introduce the product. If you adjust statistically for these extra costs, WIND actually made $.25 last quarter, an almost 80% year-on-year increase. No, WINDÆs growth is not slowing.
But if it is not slowing, how is an expected $.13 considered growing? $.15 followed by $.19 (or my improved $.25 estimate), followed by $.13 seems regressive. The answer is that WIND has always had a slow first quarter, much less than the previous quarter. However, when compared year-on-year, $.13 represents a substantial earnings growth of almost 100%. But continuing with the thought "when will Tornado begin making money", I suspect we should begin to see more substantial than expected growth this quarter - more like $.16.
In general, WINDÆs growth is of a different kind than, say, IOMEGAÆs. Most hardware or software high-tech product companies can occasionally enjoy explosive revenue growth, if they bring out a hot product that appeals to hundreds of thousands or even millions of potential users of the product. However, unless such companies can protect their market as a monopoly, such as Intel and Microsoft, or stay ahead of the competition, and all the better mousetrap companies, they inevitably suffer price erosion, leading to margin erosion, leading to plummeting stock price (witness most high tech firms such as Exabyte). This cycle is a turnoff to investors like Peter Lynch and Warren Buffett.
WIND is different. Tornado is hot, but it isnÆt a product that the man on the street wants, or is it in many company offices. Tornado is used by product development engineers doing extremely sophisticated development as a part of a significant development engineering group. It sells in the hundreds or low thousands, not hundreds of thousand or millions. Nevertheless, at $20,000 up for typical system sales, it can generate a comfortable volume. Oftentimes new buyers need to send their engineers to WIND training, and they may need other support services as well, providing additional income to WIND.
But over the years these hundreds of sales become thousands, all needing updates, new this and new that. All this leads to most of WINDÆs reported product revenues and much of their service revenues. Not a bad business, but not explosive like IOMEGA. Yet something else is going on here. Those thousands of engineers are busily developing lots of neat products, which eventually begin to appear in the market place. Sometimes this can take many years from the initial tool sale that got it going. For example, GM selected VxWorks for diesel engine control in the beginning of 1994, but the product wonÆt start to appear until model year 1998. I2O was announced by Intel et al a couple of months ago, but products based on I2O probably wonÆt begin to appear in quantity until late 1997. As the products appear, royalties begin to flow to WIND. If the production quantity is small, the unit royalty will be sizable, so the payment to WIND will be noticable. If the production quantity is large (in the millions), the payment is sizable even though the unit royalty will be much less. Over time the royalties should become enormous, perhaps displaying explosive growth (directly to the bottom line). I think within a year or two, I2O royalties alone could amount to more than what WIND will be making this year, perhaps even many times what they will make this year.
Some might fear investing in WIND is risky because of the possibility of competition spoiling the party, or a technological paradigm shift. I believe the switching costs for companies already committed to WINDÆs tools would be enormous, on par with companies still stuck using COBOL, and scientists still using FORTRAN, languages stemming from the fifties and early sixties. Pushing WIND out of GM after the diesels hit production would be more difficult than switching computer languages or database vendors. High switching costs are high-techÆs answer to brand loyalty, which leads to a business franchise, the only kinds of businesses that consistently make great returns.
What about a paradigm shift? Not probable in our lifetimes (and your childrenÆs lifetimes). The reason is that programming a 32-bit microprocessor with lotÆs of complicated functionality is no easier than programming your desktop computer. (That wasnÆt true with 4-bit and 8-bit microcontrollers with limited functionality.) Consequently, it becomes necessary to layer the software, with kernel services, hardware handling , protocol handling, multitasking, even multiprocessors, etc. And often there is a hard real time requirement, which is extremely complicated to provide, and even more difficult to know for sure it has been provided. There must be an operating system to provide the glue, like VxWorks. Indeed, one of the biggest growth areas for WIND is to replace home-grown operating systems currently used by most engineering departments which no longer can keep up with all the functional requirements enabled by the latest microprocessors, and therefore wanted by the marketing department.
WIND is not over-priced at 60 P/E because the market is not pricing in the future royalties. WIND is priced at about what any company credibly growing revenues 35% and earnings 35% annually would deserve. No analyst has factored in specific gains due to royalty growth associated with I2O or any other of many large production deals in the making. Maybe this is because they are not privy to the numbers; or maybe they are taking a wait and see attitude. Compare the analystsÆ views of WINDÆs deals with how they portray GeoworksÆ potential, or any number of internet stocks, or virtually all Biotech stocks. WIND is a great story stock, that just happens to have excellent numbers. It even has positive cash flow (interest payments), and enough money in the bank (deposit) to self-finance a takeover.
Hope this helps. IÆll know more after the H&Q show starting this weekend.
Allen, |
