Xylan Looks Ripe for the Picking
iionline.com
Jono Steinberg (2/9/99)
Following Lucent Technologies' (NYSE: LU) $19 billion acquisition of ATM pioneer Ascend Communications (NASDAQ: ASND) last month, there has been a tremendous amount of speculation as to who the next takeover candidate will be in the rapidly consolidation networking industry.
The convergence of voice and data networks has put a tremendous amount of pressure on voice companies to increase their data capabilities to effectively defend market share as data networks begin to carry voice traffic. Lucent's acquisition of Ascend will, in my opinion, serve as a catalyst for other voice companies to quickly broaden their product offering and make acquisitions of data networking companies.
Alactel Purchase of Xylan?
One company that is very vulnerable to an acquisition is Xylan Corp. (NASDAQ: XYLN). Its shares are compelling based on its strong growth rate, leading-edge product offering and takeover appeal. French telecommunications company Alcatel (NYSE: ALA) already owns 6% of Xylan, and it would not surprise me if they decided to acquire the remaining shares in the company.
Xylan is a Calabasas, California-based provider of high-bandwidth switching solutions to service providers and enterprise customers. Xylan's products improve the performance of existing data networks and enable migration to next generation protocols.
Great Numbers
Xylan's financial results have been impressive. For its fourth quarter, Xylan's net profit increased 67%, to $11 million, or $0.23 per share. Revenue growth soared by 52%, year-over-year. Xylan showed very strong sequential growth as well. When compared to the third quarter, revenue grew by 7%, to $97.4 million, from $91.1 million.
Because Xylan has historically derived a meaningful portion of its revenue from two OEMs (original equipment manufacturers), Alacatel and IBM (NYSE: IBM) it is very important to look at non-OEM revenue growth as a barometer for its business. On a sequential basis, non-OEM revenue growth was 16%. Because of the inherent lumpiness in ordering patterns of OEM's, Xylan has moved aggressively to increase its VAR (Value Added Reseller) and direct channels. This has worked out very well, as OEM revenue as a percent of overall sales has decreased to 24% in the fourth quarter from 41% in the second quarter.
Key drivers for Xylan's growth going forward include new switching solutions aimed at the rapidly growing service provider market. Xylan currently has a product offering known as Transparent LAN Service, with sales to Bell Atlantic (NYSE: BEL), Bell South (NYSE: BLS) and MCI WorldCom (NASDAQ: WCOM). Sales into this category totaled $55.8 million in fiscal 1998. Management has forecast that revenue in this category will double in fiscal 1999.
In addition, Xylan will see strong growth of its recently introduced Omni Switch Router, accounting for $14 million in revenue for the fourth quarter. Expect this new product to be a key driver in 1999 with the ability to show 100% sequential revenue growth over the next quarter.
Over the next few months we expect Xylan to announce a relationship with a major cable company for deploying switches. Xylan is working to provide high-speed Internet access over cable and telecommunications networks. This could be a key growth driver for Xylan in 1999.
Xylan's near term prospects are very strong. OEM revenue should show sequential growth as IBM takes delivery of the new OMNI S/R. The key for investors to focus on remains direct and VAR revenue growth, which we also expect to be strong.
With fiscal 1999 revenue forecast of $450 million and earnings of $1.10 Xylan is currently trading at 18 times earnings and 1.8 times revenue. These multiples do not take into account Xylan's strong balance sheet, which has cash (about $130 million) representing over 15% of its total market capitalization.
Bottom Line:
As voice and data networks continue to converge, voice players will increasingly look toward acquisitions to expand their product offerings. Xylan is a prime target, but has appeal based on its own merits as well. At $19.88, we see plenty of upside for Xylan. |
