Rande - Some information on TERN and CMTO
Smartmoney.com
NEW YORK -- If the market for cable modems is going to be so big, how come the stock prices of modem makers Terayon (TERN) and Com21 (CMTO) are getting so small? The stocks are off at least 50% from their 52-week highs, having tumbled more than 20% in the past week. That, plus strong earnings expectations made them naturals for Wednesday's screen looking for companies with lots of cash and little debt - good prospects for a skittish tech investor crowd.
Remember, cable modems enable high-speed Internet access over cable lines, and will play important roles in the phone service that big cable companies such as AT&T (T) desperately want to sell. Right now, about a million households lease cable modems from their cable service providers, who buy them from manufacturers. As technology improves, investors expect cable modems to go from a $585 million market today to a $5 billion market in 2002.
So why the long faces among cable modem investors? They fear that as Web TV and Internet telephony spread, cable modems will be available at retail outlets like CompUSA (CPU) for far less than the $300 they currently cost. Just last week, Com21 announced that average sales prices could drop as much as 8% this quarter due to increased retail competition. Credit Suisse First Boston analyst James Parmelee quickly spread the word in a report, predicting a 1% decline in gross margins as a result of price erosion.
Analysts have gotten used to 5% to 6% price declines, and when Parmelee put a 10% price decline in his model, this popped open the dumpsters - even though the anticipated effect on Com21's gross margin was less than 1%.
Moreover, as the market expands, investors fear that big-gun modem manufacturers like Motorola (MOT) and Nortel (NT), who are No. 1 and No. 2 in the cable modem market, will drown the smaller firms because of their superior distribution, brand recognition and access to capital.
But Com21 and Terayon - Nos. 3 and 4 in U.S. market share, according to Cable Datacom News - may be able to survive falling prices with up-to-date technology, Internet sales and bulk sales to cable service providers. Com21, which booked $48 million in revenue last year, is already a supplier to TCI, AT&T's biggest subsidiary. Terayon, which had $32 million in sales last year, sells to industry leaders like Rogers Cablesystems, Canada's largest operator, and TCA Cable (TCAT). And these cable service providers are in no hurry to cut vendors. In fact, AT&T spokesman Mark Siegel says Ma Bell will make sure to contract with several vendors as it runs voice-over-cable trials in six cities this year.
One way for Com21 and Terayon to insure their own survival is with superior products. "These guys had better develop enhanced products fast if they want to survive," explains Claude Romans, an analyst with market researcher Ryan Hankin Kent. They seem to know it. Com21 CEO Pete Fenner and CFO Dave Robertson hightailed it to New York to meet with investors and media last week after analyst Parmelee dropped his bomb on the sector. Fenner showed off a card that you can slide right onto an old modem to make it voice-ready, which he says makes the product easy for cable companies to use in upgrades and for factories to produce. Meanwhile, Terayon unveiled a technology that lets cable companies offer high-speed Internet access without sacrificing any of the network space that cable channels currently occupy.
The companies are also working on different ways of reducing background noise when cable modems are used for telephone calls. Com21 is testing filtering devices, and Terayon is using code in the modem itself. Fenner says he's talking to Cox Communications (COX), which is successfully offering cable phone service, about running "big trials" of its noise-reduction equipment.
While preparing these innovations for market, both companies are whittling down their manufacturing costs. Com21 has teamed up with Celestica (CLS), an outsourcing shop known for its cost-efficiency, at a new factory in Mexico. Terayon has increased its production speed since last winter, thanks to a completely integrated chip of its own design, says spokesman John Hamburger. The results of these moves should show up in the companies" profit margins. Joel Achramowicz of Preferred Capital Markets, says that investors should take heart if Com21 can keep its gross margins in the 39% range as it moves production to Mexico this year.
Finally, these companies are setting up tents in cyberspace, where retail costs and barriers to entry are low. Com21 is preparing an Internet sales channel with a fulfillment specialist, hoping to sell through links on cable companies' Web pages; Terayon's Hamburger pins his hopes on e-commerce partnerships with computer makers and players to be named later.
Are these stocks slam-dunks? Not at all - especially with 3Com (COMS) and Cisco Systems (CSCO) establishing themselves in the market. But they aren't sitting ducks either. Analysts expect annual revenue at each to climb at an average of 70% over the next two years. Yet both lost more than twice as much value as other equipment stocks in the recent selloff. Antec (ANTC), a cable network maker, fell only 10% last week; 3Com dropped only 7%.
Indeed, it looks like Wall Street overreacted to Parmelee's report. He wasn't predicting Armageddon, just a percentage point drop in gross margins. Even he said in his report, "We would be buyers on weakness." It looks like he got his wish.
PS: CMTO also bought $1M worth of Paul Allens HSAC |
