TERN: BETTER-THAN-EXPECTED RESULTS WITH SOLID METRIC GROWTH ON FALL
FRONTS...
Bankers Trust Research/BT Alex. Brown Research
Lawrence Marcus,Justin Post
April 15, 1999
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TERAYON COMMUNICATIONS SYSTEMS INC. [TERN] "STRONG BUY"
Better-Than-Expected Results With Solid Metric Growth On All Fronts--
Reiterate
"Strong Buy" Rating On The Shares
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Date: 04/14/1999 EPS 1998A 1999E 2000E
Price: 55.5 1Q (0.48) (0.23)A (0.07)
52-Wk Range: 58 - 7 2Q (0.45) (0.23) 0.00
Ann Dividend: 0.0 3Q (0.44) (0.20) 0.07
Ann Div Yld: 0.00% 4Q (0.33) (0.15) 0.19
Mkt Cap (mm): 1,104 FY(Dec.) (1.68) (0.81) 0.22
3-Yr Growth: 75% FY P/EPS NM NM NM
CY EPS (1.68) (0.81) 0.22
Est. Changed Yes CY P/EPS NM NM NM
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52 week range since 8/18/98 ipo priced at 13
HIGHLIGHTS:
--TERAYON REPORTED BETTER-THAN-EXPECTED EPS operating loss of $0.23
(versus $0.27 expected) on $15.9 million in revenue (versus $14 million
expected.)
--TERAYON CONTINUES TO OUTPERFORM EXPECTATIONS in financial performance
(better than expected 1Q), metrics (headend footprint, modems sold,
gross profit), product shipments, and strategic progress (agreement with
Rogers for telephony).
--RAISING ESTIMATES: 1999 to loss per share estimate of $0.81 on $76.9
million of revenue from loss of $0.86 on $72.0 million of revenue. 2000
to EPS estimate of $0.22 on $138.0 million of revenue from EPS of $0.20
on $135.0 million of revenue.
--DERIVED BACKLOG GROWING: Terayon's headend installed base of 655 units
implies a 290,000 modem unit backlog (assuming 600 modems per headend),
while Terayon's enabled homes passed of 7.5 million implies 650,000
modem unit backlog (assuming 10% homes passed penetration.)
--HITCHED TO @HOME'S WAGON (OR VICE VERSA.) Terayon is benefiting from
@Home as the preferred modem vendor for the most aggressive MSOs
deploying @Home's service.
--CATALYSTS include: greater commitment by MSOs, new MSO deals (expands
footprint-now 7.5mm marketable homes passed), acceleration in cable
modem deployments (lower install times), and M&A (new services, broader
footprint.)
--WE REITERATE OUR "STRONG BUY" RATING on the shares.
--WE ARE RAISING OUR 12-18 MONTH PRICE TARGET TO $80 per share, based on
100x estimated 2001 EPS of $0.80 or 10x 2001 revenue.
DETAILS:
STRONG QUARTERLY RESULTS
Terayon reported better-than-expected 1Q net operating loss of $0.23,
versus our estimate of $0.27, and has established encouraging revenue and
metric growth. The Company's 1Q revenues of $15.9 million and gross margin
percentage of POSITIVE 12% were significantly higher than our estimates of
$14.0 million and positive 7%, respectively. Higher-than-expected sales
were a result of a stepped-up deployment of headends and modems by
Terayon's existing MSO customers and the addition of five new customers in
the quarter. The Company's better-than-expected improvement in gross
margin was due to scale gains from higher revenues, volume shipments of the
Company's new (lower cost) single board modem and competitive pricing from
its vendors. Operating expenses of 45% of revenues was better than our
estimated 48% due to increased revenues and management's cost control.
Terayon's headend footprint was well ahead of our forecasts. Sales of 170
headends during 4Q was significantly greater than our estimate of 125
headends, and the number of homes passed reached 7.5 million during the
quarter (vs. our estimate of 5.2 million) driven by the addition of Rogers.
We believe that these metrics are especially encouraging because future
cable modem sales are dependent on an established headend base. The
Company's expanding headend footprint contributed to higher modem shipments
during the quarter of 37,500 units (vs. our estimate of 36,000 units).
International sales accounted for 34% of total sales and shipments to Shaw,
Cablevision and Sumitomo accounted for 31%, 18% and 14% of sales
respectively.
BALANCE SHEET
Terayon's net cash and short-term investment balance increased to $108
million from $29 million during the quarter primarily due to the completion
of a secondary offering of common shares in the quarter. Accounts
receivable increased $4.4 million during the quarter (to $8.0 million)
which increased DSOs to 45 days. Inventory, which represents unshipped
finished goods only, decreased to $1.1 million in the quarter. Despite
low inventory levels, the Company should be able to meet demand in 2Q.
IMPORTANT ACCOMPLISHMENTS
The Company achieved several key milestones in 1Q 1999, which include:
-- Addition of new customers. In 1Q 1999 Terayon became the primary
supplier of cable modems and headend systems to UPC (European MSO with
4.9 million homes passed) and also signed a supply agreement with Rogers
in Canada. These new agreements, combined with Terayon's existing
agreement with Sumitomo in Japan, Megacable in Mexico and NetBrazil in
Brazil, have helped the Company establish an impressive international
footprint.
--Increased gross profit. The Company's gross profit margin increased to
12% in 1Q 1999 from 3% in 4Q 1998 as the Company continued to benefit
from greater volume shipments of its new single board modem and
competitive pricing from its two vendors.
--Completion of secondary offering. Terayon improved its balance sheet
(a.k.a. long-term viability) and attractiveness as a vendor with the
addition of $79 million in cash during the quarter. More cash enhances
the Company's strategic opportunities.
--Progress toward the development of a DOCSIS 1.2 cable modem standard.
The Company completed a draft specification of the DOCSIS 1.2 standard has
begun development of a highly integrated, low-cost chip that will form the
basis of its own DOCSIS 1.2 cable modem system. Terayon continues to make
progress on its plan to be first to market with DOCSIS 1.2 compatible
products.
TERAYON HITCHED TO @HOME'S WAGON (OR VICE VERSA)
Terayon is benefiting from @Home as the preferred modem vendor for the most
aggressive MSOs deploying @Home's service. Roughly 40%+ of @Home
subscribers come from MSOs aggressively rolling out Terayon (Shaw--81,000
data subscribers, Rogers--54,000, and Cablevision--11,000 represented over
40% of @Home's 331,000 4Q 1998 data subscribers.) @Home's Japanese joint
venture with Sumitomo (an investor in and deployer of Terayon) could help
Terayon generate even greater international sales.
RAISING ESTIMATES
We are raising our earnings and revenue estimates based on greater headend
deployments, positive industry developments and enhanced company
positioning. Estimates are being raised as follows:
New EPS* Old EPS* New Revenue** Old
Revenue**
2Q 1999 ($0.23) ($0.24) $17.0 $16.0
3Q 1999 ($0.20) ($0.20) $20.0 $19.0
4Q 1999 ($0.15) ($0.16) $24.0 $23.0
1999 ($0.81) ($0.86) $76.9 $72.0
1Q 2000 ($0.07) ($0.10) $28.0 $26.0
2Q 2000 $0.00 ($0.03) $31.0 $29.0
3Q 2000 $0.07 $0.07 $36.0 $35.0
4Q 2000 $0.19 $0.22 $43.0 $45.0
2000 $0.22 $0.20 $138.0 $135.0
* Loss in parenthesis
**$ in millions
IMPRESSIVE IMPLIED BACKLOG
--Terayon's headend installed base of 655 units implies a 290,000 modem
unit backlog assuming 600 modems per headend.
--Terayon enabled homes passed of 7.5 million implies a backlog of 650,000
units over the next 18-24 months assuming a 10% penetration level. @Home
has averaged 5-6% penetration in systems that have been active 18 months,
but has achieved penetration greater than 12% in some markets.
Our modem unit forecasts are 206,500 in 1999 and 461,000 units in 2000. In
1998 the Company sold 61,000 units. Terayon appears to have sufficient
backlog to achieve its modem targets.
LARGE AND GROWING MARKET OPPORTUNITY
Terayon remains well positioned in the early stages of a high growth market
that includes cable modems, set top boxes and IP telephony. Industry cable
modem units shipped are forecast to be 4+ million units in 2001. Digital
set-tops shipments should be 50% higher. A variety of industry
announcements bolsters cable modem prospects in our view. For example,
@Home is expected to close its deal with Excite in late May. The combined
Excite @Home entity has the potential to increase the breadth, depth and
quality of the consumer broadband Internet experience with richer content,
commerce and community in an all-in-one service. xDSL looms as competition
that should incentivise cable companies to accelerate deployment.
RISKS
Potential issues and controversies may include: uncertain timing of the
DOCSIS 1.2 standard and adoption of earlier standards (1.0 and 1.1) or non-
standard products, dependence on cable companies, lumpiness in orders which
impacts quarterly earnings predictability, and product release delays.
Also, the unlock of 9.0 million shares from the Company's secondary
offering occurs on April 22, 1999.
CATALYSTS
We believe potential catalysts for the stock include the following:
--Accelerated cable modem deployment which can be driven by modems at
retail, decreased install times, greater marketing push and pressure by
XDSL and cable companies.
--Expanded footprint through more cable deals.
--Further improvement in metrics and the Company's operating model.
REITERATE OUR "STRONG BUY" rating as the company is showing improved
execution and expanding footprint in the rapidly evolving cable modem and
broadband services market. We are raising our 12-18 month price target to
$80 per share, based on 100x estimated 2001 EPS of $0.80 or 10x 2001
revenue. We expect stock price to be driven more by appreciation for
market opportunity and company positioning than by earnings driven
valuation metrics. |
