Small Caps, Big Potential
Much has been made over the past few weeks of the rotation out of the tech
sector and into cyclicals, such as paper, chemical and metals stocks. Less
publicized but equally noteworthy has been the shift in investor preference from
large-cap to small-cap stocks. In the past month the Russell 2000 index has
risen by 8.1%, easily outperforming the S&P 500 (+1.1%), Nasdaq Composite
(-3.5%) and Nasdaq 100 (-6.3%). It's been a long time in coming, but
small-caps finally look ready to play catch up.
In today's Brief we profile two small-cap tech companies that Briefing.com
believes offer exciting potential for much better than market capital
appreciation. The two candidates are Wind River Systems (WIND 14 1/4 -1/4)
and Com21 (CMTO 29 15/16 +1 15/16).
Wind River Systems
Our first selection may surprise you in that the stock hasn't performed very well
as of late. Disturbed by an earnings warning and news that the CEO was
resigning, investors pummelled the thinly traded stock, taking it down from the
mid-30s to as low as 11 1/4 in a matter of months. But as is often the case with
lightly followed, thinly traded stocks, such moves get exaggerated. And
Briefing.com contends that that is exactly what has happened here.
Wind River makes real-time operating systems (RTOS) for embedded
processors. Embedded processors are essentially highly specialized computers
within appliances or automated systems. Typical industries/applications that use
embedded processors include:
Communications: control chips within switches, routers, hubs, satellites.
Office: printer and copier logic.
Industrial: factory automation machinery.
Government: space and defense systems
Consumer: DVD, TV, WebPhones, and set-tops
The market for outsourced embedded software is expected to grow at nearly a
50% annual rate over the next few years. WIND is currently the second largest
player in this fast-growing industry, with roughly a 22% share. However, traders
have grown concerned that increased competition from the likes of Microsoft
(MSFT) and Sun Microsystems (SUNW) will cut into WIND's share. Though it is
never wise to discount these two tech heavyweights, WIND's proven expertise
in this area, combined with its early lead and the industry's rapid growth,
suggest that WIND should have no trouble posting solid top- and bottom-line
growth over the next several years.
As for the current quarter's earnings woes, Briefing.com sees them as
temporary given that they stem from integration difficulties. WIND is projected to
earn $0.11 in Q1, in line with the year ago period. For FY00 and FY01, the
company is expected to earn $0.76 and $1.00, respectively. Meanwhile, the
long-term growth rate is projected at 42.7% - roughly 6x the rate of the overall
market. Based on these consensus figures, WIND trades at 18.8x and 14.3x
projected results with PEGs of 0.44 and 0.33. It is Briefing.com's contention that
at such discounted multiples, any bad news is largely factored in. If WIND
merely lives up to expectations, the stock should have little trouble testing the
20 area over the next 12- to 18-months.
Com21
Unlike WIND, Com21 is showing signs of coming to life. Bolstered by AT&T's
acquisition of MediaOne, the stock gapped higher on increased volume in
yesterday's session. CMTO is a leading global provider of cable modem
technology for delivering high-speed Internet access over CATV systems. The
company enables cable operators and service providers with the abilities to
provide high-speed, cost-effective Internet access to corporate telecommuters,
small businesses, home offices and residential users. In other words, Com21 is
well positioned to exploit the broadband bandwagon.
Just how big will the market get? Well, according to Forrester Research 60 mln
US homes will be online by the year 2002, of which 16 mln will have high-speed
access, and 13 mln of those will enjoy connectivity over cable. Outside the US,
high-speed online users will total an additional 24 mln. Naturally with growth
potential that large, Com21 will have to fight to defend its turf from potential
competitors such as Siemens, Motorola and/or 3Com. But like WIND in its
market, CMTO has an early lead, strong technology and the management team
to get the job done. According to one study Com21 ranked third in worldwide
cable modem shipments for 1998.
Though CMTO has yet to turn a profit in its relatively short history as a publicly
traded company, revenue growth remains impressive. For the first quarter of
1999, Com21 posted revenues of $19.2 mln, a 174% jump from year-ago
levels. The company also noted that its book-to-bill ratio was greater than one;
product margins improved by over 400 basis points; and costs were coming
down.
Given improved operating efficiencies and strong top line growth, market
expects company to post earnings of $0.16 in FY00... The consensus forecast
for the FY99 calls for a loss of $0.41... Clearly, the company trades at a lofty p/e
multiple but p/s ratio of 10.5x not out of line given much better than market
growth. CMTO projected to deliver average annual growth of 50% over next 5
years.
Another factor worth considering is that Com21 is/remains a prime takeover
target. Among the potential suitors are 3Com, Lucent, Cisco and Siemens.
Considering the frenzy created by AT&T's aggressive play for MediaOne, don't
be surprised if we see a slew of deals in the broadband equipment area over
next few months.
Cutting edge technology, exceptional industry/company growth rates, modestly
discounted valuations, strong, experienced management team, industry
consolidation and improved technicals suggest that Com21 is poised for a
near-term upside break out. Briefing.com's 12- to 18-mo target is 45. |
