NBMO - Orckit: ADSL activity picking up; reiterate BUY.
- ADSL activity picking up (see industry note, dated 3/30/99).
- Orckit should benefit in 1999: outlook with GTE is very positive.
- In addition, Orckit is well positioned to win second-source business with RBOCs in 1999.
- Orckit profitability expected in 2H99; company is comfortable with forward estimates.
Investment Opinion. We are reiterating our BUY rating on Orckit, with a $30 price target. Orckit represents a near pure-play on the expected deployment of ADSL for faster connections to the internet. Despite the recent appreciation of other companies in the xDSL space, shares of Orckit have lagged. Recent checks in the market indicate that ADSL deployment appears to be picking up steam, as both carriers and vendors have become more bullish in their predictions regarding both timing and magnitude. While other companies should also benefit, we believe that shares of Orckit offer particularly strong appreciation potential due to the ADSL pure-play aspect as well as the earnings leverage from strong ADSL business.
- ADSL activity picking up (see industry note, dated 3/30/99). • As we describe in the industry noted also dated today, we believe that the recent increases in CLEC funding, combined with the recent success of cable modems have caused the RBOCs to begin to feel pressure from these competitive access providers, and are beginning to respond. We further believe that in 1999, the RBOCs will shift their spending focus from long-distance toward efforts to upgrade networks for broadband access. Along these lines, Alcatel recently noted that it expects over 3,000 C.O.s to be equipped for ADSL access in 1999.
More specifically, Bell Atlantic recently announced that, whereas it previously expected to equip 250 C.O.s for ADSL access, it has increased this number to 750.
- Orckit should benefit in 1999: outlook with GTE is very positive. As we have noted previously, Orckit's GTE ADSL contract should continue to be a primary driver of revenue growth for Orckit, as GTE continues to ramp up its ADSL deployments. Orckit, which shipped 40,000 links in 1998 and now covers 300 central offices, remains very well positioned to benefit as ADSL services continue to roll out at GTE.
- In addition, Orckit is well positioned to win second-source business with RBOCs in 1999. In addition to its position at GTE, we believe that Orckit is well-positioned to be named as a second-source provider of ADSL equipment at other large U.S. carriers. Along these lines, Alcatel is clearly the largest ADSL provider in the U.S. (due to its win in the JPC contract), and this is not expected to change. However, virtually all the RBOCs are expected to name second-source providers at some point in 1999, and we believe that Orckit is particularly well-positioned to benefit. Remember that Orckit is the only ADSL equipment provider with an ADSL/Frame Relay solution, in addition to an ADSL/ATM solution.
- Orckit profitability expected in 2H99. We continue to believe that Orckit will turn profitable beginning in the second half of 1999, most likely in the fourth quarter. Note that this expectation of profitability is dependent upon both revenue growth and expected cost reductions. Conversations with management indicate that the cost reduction program remains on schedule, with the redesigned chip
expected to be integrated in Q2 and shipping in Q3. In addition, note that any significant pickup in demand at GTE may allow Orckit to turn profitable earlier than this expected timeframe. Finally, it is worth remembering that because (1) Orckit's operating expenses are relatively fixed and (2) the company has fewer than 20 million shares outstanding, the potential ramp in revenues expected to begin in 3Q99
can quickly translate into significant EPS growth.
- Company remains comfortable with annual 1999 and 2000 revenue and EPS estimates. Based on recent conversations with management, we believe that the company remains comfortable with our estimates for 1999 and 2000. As a reminder, we are looking for revenues to ramp from $91 million in 1999 to $150 million in 2000, and we are looking for EPS to go from ($0.90) in 1999 to $0.60 in 2000. In the upcoming March quarter specifically, we are looking for revenues of $13.0 million and EPS of ($0.38).
Investment Opinion. We are reiterating our BUY rating on Orckit. Orckit represents a near pure-play on the expected deployment of ADSL for faster connections to the internet. Despite the recent appreciation of other companies in the xDSL space (note the rise in Aware, AWRE), shares of Orckit have lagged. Recent checks in the market indicate that ADSL deployment appears to be picking up steam, as both carriers and vendors have become more bullish in their predictions regarding both the timing and magnitude of ADSL deployments. While other companies should benefit from this (including Alcatel (ALA-$23 1/2) and Lucent (LU-$108), and possibly PairGain (PAIR-$107 7/8)), we believe that shares of Orckit offer particularly strong appreciation potential due to the ADSL pure-play aspect of the company, as well as the earnings leverage from strong ADSL business.
Given this strong earnings leverage, we believe that Orckit has earnings power of around $1.50 in 2000; applying a multiple of 20x to this estimated 2000 earnings power, we are reiterating our BUY rating on ORCTF, with a price target of $30. |
