**** Hambrecht & Quist Report ****
May 14, 1999 - 6:32am
Company: Aware, Inc.
Price: 58.125
Recommendation: Buy
Notes: a,
Date: 5/14/99
1 of 2 Initiating Coverage with a BUY Rating
We are initiating coverage on AWARE with a BUY rating based on our belief that
despite the company's valuation, we believe over the near term, the company
will continue to benefit from news announcements further endorsing the overall
growth of the xDSL market, and AWARE's future market share within the sector.
1998 A 1999 E 2000 E
Q1 EPS $(0.07) $0.03A $0.06
Q2 EPS (0.06) 0.03 0.08
Q3 EPS 0.00 0.03 0.10
Q4 EPS 0.03 0.07 0.12
FY EPS (0.12) 0.16 0.35
FY REVS (M) 12 21 33
CY EPS (0.12) 0.16 0.35
CY P/E NM NM NM
FY Ends Dec Current Price $64.00
52-Week Range $87-4 Market Cap(M) $1,321
Shares Out(M) 23 Book Value $1.81
Net Cash/Share $1.25 Growth Rate 40%
CY00 P/E-to-Growth NM%
Company Overview
AWARE sells Intellectual Property (IP) software for the Asymmetric Digital
Subscriber Line (ADSL) industry standard DMT line code, to communications chip
vendors thereby enabling the production of ADSL chip sets. While there are a
number of chip vendors who make DMT chip sets, AWARE is the only independent
vendor of DMT IP, and currently, the only real option for any new chip vendor
to use if they want to enter the market for xDSL chip sets. Additionally,
AWARE has a very strong position in G.Lite xDSL IP. G.Lite enables easy
provisioning of xDSL lines and, as a standard has been endorsed by the
computer industry as a way to accelerate the deployment of broadband access
services. AWARE has a patent pending of G.Lite. If the company is granted
this patent, they will be able to receive a royalty payment on every G.Lite
chipset sold regardless of whether the chip vendor has a partnership with
AWARE or not. The outcome of this patent is expected sometime in 2000.
The company currently has partnerships with several prominent chip
manufacturers including Analog Devices, Lucent Microelectronics, Seimens
Semiconductor and STM Microelectronics. AWARE license's its software to these
chip vendors and receives an up front payment (in the millions of dollars)
that is recognized over several quarters. After volume production of chips
begins (which has not yet happened and is at least partially a function of the
carriers deployment of residential xDSL services), the revenue model for AWARE
changes and they begin to receive revenue on a 'per chip sold' basis, which we
estimate to be approximately $3. This business model is obviously exceedingly
profitable, however, the flip side is that the revenue opportunity, at $3 per
chip is significantly smaller than for the chip vendors ($30-$50 / chip) or
the system vendors ($300 -$500 / line).
Growth Drivers
AWARE benefits almost exclusively from the deployment of xDSL services, which
we believe is at the very early stages of dramatic growth. More specifically,
the company recognizes revenue when one of its partners sell xDSL chip sets to
the communications systems vendors. The company has a particularly strong
position in the G.Lite segment of xDSL.
How AWARE makes money
In order to forecast revenues for AWARE, several assumptions must be made.
They are 1) the number of ADSL lines deployed worldwide. 2) AWARE's market
share of xDSL lines deployed. The market share assumption also requires
several suppositions. They are, the level of success that AWARE's partners
have in supplying chips to the systems vendors (the companies actually bidding
on service company contracts).
Our rough assumption over the next several years is that approximately 1
million lines will be deployed in 1999 and this will grow to 2.5 million in
2000. We also expect AWARE IP to be used in approximately 50% of lines
deployed.
Competitive landscape
AWARE's eventual revenue depends on the success of the company's partners.
The following is a brief description of the company's partners offerings:
*Analog Devices - ADI was the company's first partner (and at the time the
exclusive supplier). ADI xDSL chips are full-rate chip sets (fully compatible
with the G.Lite standard) and the target customers for these products are the
traditional telecom equipment vendors. ADI's ADSL chipsets are being used by
companies that represent approximate market shares of: 65% in public
switching, 90% in digital loop carrier (DLC), 40% in analog modems, and 65%
in routers. Several previously announced large customers of ADI are 3Com and
Ericsson.
*Lucent Microelectronics - Lucent Micro is the leading vendor of
communications chip sets to the PC industry. They have licensed a G.Lite IP
from AWARE and are currently selling these chips directly to both Compaq and
DELL.
*Infineon (formerly known as Siemens Semiconductor and recently spun-off from
Siemens) - Infineon has integrated G.Lite into switch line cards for upgrade
of existing central office equipment. This solution leverages existing CO
equipment and operations infrastructures, thereby providing the service
provider with a low cost way to upgrade to xDSL. Infineon's largest customer
is Siemens, but as a result of the recent spin-off from Siemens, we believe
that Infineon will be able to sell to Siemens competitors too.
*STM Microelectronics (formerly SGS Thompson Microelectronics)- This was the
company's most recent partner. The company has a large market share for
communications chipsets in Europe.
There are several other companies who sell xDSL chips who have not licensed
AWARE's technology, they include:
*Alcatel - Alcatel is one of the only fully integrated xDSL players in that
they are the global systems leader, in terms of lines deployed, manufacture
their own chips, and also sell these chips on the merchant market. Currently,
Alcatel is experiencing a certain level of success selling these chips to
their systems level competitors. This is a direct result of interoperability
issues. At this early stage of market development, interoperability is still
and issue (and will probably be an issue for the next several months), and
with Alcatel owning the majority of lines on the CO side, other vendors, in
order to minimize issues, are buying their chips from them as well. We
believe that this is a near term phenomena and that over time the traditional
communications chip vendors will win back this market share.
*Texas Instruments - TI bought AMATI several years ago and their technology is
the source code behind the TI xDSL product offering. We believe that TI has
lost several key accounts in this space over the past year.
*Conexant - In order to get into this market, Conexant licensed its line code
from PairGain. At this time, these chips are not currently widely available.
*Fujitsu - In order to get into this market, in 1997, Fujitsu licensed its
line code from Orckit.
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