UNPH/misc. reading
01:29am EDT 2-Jul-99 Needham & Co. (David Wong (212) 705 0314) GALT VTSS UNPH
Communications Chips: Raising Price Targets, Very Positive On Group
Needham & Co., 445 Park Avenue, New York, NY 10022
2 Jul 1999
David Wong, Ph.D., dwong@needhamco.com, (212) 705 0314
Ryl Ashley, rashley@needhamco.com, (212) 705 0406
Communications Semiconductor Industry
Raising Price Targets, Very Positive on Group
Summary
* We are raising price targets for most of our recommended stocks, as we look a
quarter further out and revise our price target multiples in line with the
market.
* Our top stock pick remains Galileo Technology (GALT, $45.00, Strong Buy). We
think Galileo stock could appreciate by nearly 100% in the next year and we are
raising our six to 12 month price target to $85.
* We think that Vitesse (VTSS, $70.56, Strong Buy) offers excellent visibility
for revenue and earnings growth. We are raising our six to 12 month price
target to $100.
* We view Uniphase (UNPH, $168.00, Strong Buy) as a company that has one of the
best growth dynamics, as well as of one of the highest barriers to entry in the
communications component space. We are raising our six to 12 month price target
to $200.
Strength in Fundamental Business, Market Assigning Higher Multiples
We expect that in July earnings release period, the news will be uniformly good
from the companies we follow, both in terms of reported results as well as
bookings and prospects into the future. As a result, we are extremely positive
on the group and the price appreciation potential of the stocks. We believe
that the bright outlook and increasing investor awareness of the strength of the
communications chip sector has contributed to the expansion in P/E multiples
for these companies. Table 1 shows how the average P/E for a group of selected
communications chip companies has risen over the past few months.
Table 1: Average P/E for AMCC, PMCS, RFMD, TXCC, UNPH and VTSS
Date P/E Date P/E Date P/E
1/31/98 32.14 7/31/98 36.32 1/31/99 50.83
2/28/98 36.87 8/31/98 28.13 2/28/99 46.47
3/31/98 37.30 9/30/98 26.86 3/31/99 53.83
4/30/98 40.79 10/31/98 35.05 4/30/99 53.04
5/31/98 34.99 11/30/98 39.78 5/31/99 53.11
6/30/98 37.55 12/31/98 47.27 7/1/99 72.02
(P/E calculated as price divided by next 12 mths (NTM)EPS estimates from First
Call. NTM EPS computed as the wieghted average of current and next year fiscal
EPS estimates.)
Source: First Call, Bloomberg, Needham & Co. calculations.
Table 2 shows valuation data for companies we cover, in order of highest to
lowest P/E. P/E based on next twelve months consensus EPS (the four quarters
September 2000 to June 2001) is, for the most part, ranging between 60x and 90x.
This is substantially higher than the 40x to 50x multiple range we have used
to derive our price targets in the past.
* We believe that it is appropriate to raise P/E multiples used for our price
targets to the 50-65x range. This is conservative in that it allows for some
contraction of price multiples from the current levels. Should multiples stay
up at the current levels, investment returns on our recommended stocks are
likely to be higher than our price targets imply.
* Given that we are at the end of the June 1999 quarter, we think it is
appropriate to look one quarter further out. We are now basing our price
targets on our "out-year" July 2000 to June 2001 EPS estimates.
* Our revised price targets are shown in Table 2.
Table 2: Valuation Data for Companies We Follow (Highest to Lowest P/E)
Price New 6-12
Next 12 Price Target Mth Price
Ticker Mths EPS (7/1/99) P/E Rating P/E* Target*
MAKR $0.08 $32.13 402 Buy na $33
BRCM $1.08 $137.69 127 Hold na na
MMCN $0.57 $50.00 88 Strong Buy 65 $55
UNPH $1.92 $168.00 88 Strong Buy 65 $200
TXCC $0.56 $46.56 83 Buy 65 $50
PMCS $0.86 $64.41 75 Hold na na
AMCC $1.10 $81.50 74 Buy 60 $90
RFMD $1.06 $72.00 68 Buy 55 $82
ANAD $0.52 $34.88 67 Buy 50 $44
VTSS $1.14 $70.56 62 Strong Buy 61 $100
AHAA $1.12 $44.50 40 Buy 40 $56
LEVL $1.39 $52.06 37 No opinion na na
GALT $1.25 $45.00 36 Strong Buy 50 $85
OBAS $0.44 $7.19 16 Buy 25 $12
RFMI $0.64 $9.63 15 Hold 15 $10
(1) Price target is (the assigned P/E multiple) x (our July 00 to Jun 01 EPS
estimate).
(2) NTM EPS estimates are First Call consensus estimates for Sep 99, Dec 99, Mar
00 and Jun 00 quarters except for Broadcom and TranSwitch. For Broadcom we
have used our own EPS estimates rather than consensus estimates as we believe
that the general expectation (and history) is that Broadcom will exceed
consensus estimates substantially. For TranSwitch we have used our own, fully
taxed estimates.
Source: First Call (consensus estimates), Needham & Co. estimates.
Galileo has the lowest P/E valuation of the pure-play communications chip
companies.
* We think that Galileo's stock offers the greatest appreciation potential in
the group and it remains our top pick. We arrive at a six to 12 month price
target of $85 (nearly 100% appreciation) for Galileo by using a multiple of 50x
out-year estimated EPS. This P/E multiple is much lower than the 60-80x next 12
month EPS range that the market is giving to most of the companies in the
group. We believe that as Galileo further establishes itself as the leader in
mid-range Fast and Gigabit Ethernet switches for LAN applications, the stock
could command a multiple which is in the middle of the range for the group,
offering substantial upside to our price target.
* We believe that booking activity for the Galnet II switch chipset and other
Galileo products was very strong throughout April, May and June 1999. We are
expecting Galileo to report revenues and EPS that are in line or higher than our
own estimates and consensus in the June 1999 quarter.
* We think that visibility is improving for Galileo, and believe that same
quarter turns business will drop from about 40% in the June quarter to 30% or
less in the September quarter.
* We believe that Galileo is on track to roll out its Layer 3 capable switch
product based on the Galnet II, as well as a new remote access product in the
September/October time frame.
We believe that some of the exceptional qualities of Vitesse have been
overlooked. We think that Vitesse's position towards the lower end of the P/E
range offers a great opportunity for investors to benefit both from Vitesse's
strong earnings growth and a potentially expanding P/E multiple. We view
Vitesse as one of the best companies in the group because:
* Vitesse's backlog remains at between 4 to 5 months of revenue. Vitesse's
enters each quarter with essentially 100% of business fully booked.
* Vitesse has a dominant position in OC-48 (2.5 Gb/s) physical layer chips. We
think that the OC-48 market is relatively young, and we expect to see
accelerating growth in OC-48 business over the next few years as OC-48 expands
beyond long haul applications.
* We believe that interest in OC-192 (10 Gb/s) products is beginning. We think
that this could be an important growth area for Vitess in the second half of
2000 and beyond.
* We believe that Vitesse's recent acquisitions and its own internal development
efforts have given itproducts that increase its addressed markets by more than
more than 2x. We think that Vitesse's core physical layers markets will
continue to grow at more than 40% per year for several years, and that the
addition of revenues for protocol processing and switching products could help
Vitesse to grow at a rate of more than 50% for the indefinite future.
We view Uniphase as a company that has one of the best growth dynamics, as well
as of one of the highest barriers to entry in the communications component
space. In addition:
* We expect the merger with JDS-Fitel to be completed towards the end of the
first week of July 1999. We think that this merger is likely to have an
accretive effect of 10% or more on EPS, higher than the "low single digit"
guidance that Uniphase has given.
* The demand for both Uniphase and JDS-Fitel products is so strong that revenues
for many of the product lines (including pump lasers and cable transmitters)
are production limited. We expect this situation to continue through the rest
of the year.
* We expect strong demand and ramping production of source lasers to be a key
growth driver in 2000.
* We think that growth of source and pump lasers for communications and
expanding applications for optoelectronics in communications could continue to
drive Uniphase's growth at 60% or higher for many years, well into the next
decade.
We think that MMC Networks presents a particularly good investment opportunity
because:
* We believe that strength from key customers and growing business momentum in
the last few months could enable MMC to exceed estimates for the June 1999
quarter, prompting upward revisions in estimates for future quarters.
* MMC has a high quality customer list with Cisco accounting for more than 50%
of revenues, IBM about 20% of revenues, and the potential that some other
companies (Lucent, Siemens, Nortel, Ciena, 3COM) could emerge as major customers
over the next several quarters. The announced acquisition of Netcore (an MMC
customer) by Tellabs adds Tellabs to MMC's customer list.
* MMC is the leader in switches for high end ATM and Ethernet applications. We
do not believe that there is any significant merchant competition in this space
at the moment. MMC's can thus grow at a rate that is above the growth of its
end markets, as it takes share from internally developed ASIC solutions at
systems houses.
Tweaking Estimates for Broadcom
To maintain consistency of our estimates with reported pooling-of-interests
adjustments reported by Broadcom in a recent SEC filing, we are tweaking our
calendar 1999 EPS estimate from $0.77 to $0.78. Our quarterly EPS estimates are
$0.18 for June 1999, $0.21 for September 1999 and $0.25 for December 1999.
This report is for information purposes only and does not constitute a
solicitation or an offer to buy or sell any securities mentioned herein. While
the information contained herein has been obtained from sources believed
reliable, we do not represent that it is accurate and it should not be relied
upon as such. Any opinions expressed herein reflect our judgement at this date
and are subject to change from time to time. This firm and/or its directors,
affiliates, officers, employees or members of their immediate families may have
a long or short position in the securities mentioned in the report or in
options, futures or other derivative instruments based thereon. Needham &
Company and/or its affiliates may make a market or deal as principal in the
securities mentioned in this document or in options or other derivative
instruments based thereon. Needham & Company may have managed or co-managed a
public offering of or acted as initial purchaser or placement agent for a
private placement of any of the securities of any issuer mentioned in this
document within the last three years, or may from time to time perform
investment banking or other services for, or solicit investment banking or other
business from, any company mentioned in this document. Additional information
on the securities mentioned is available on request. c Copyright 1999 Needham &
Company, Inc. _______________________________________________________________
Communications revolution speeds up
New (and old) firms vie to be giants of the 21st Century
By Jeffry Bartash, CBS MarketWatch
Last Update: 6:32 PM ET Jul 1, 1999 NewsWatch
WASHINGTON (CBS.MW) -- If you listen to the experts at Thomas Weisel Partners, we are entering another phase in the communications revolution.
Thomas Weisel is the latest brainchild of its namesake, the co-founder of Montgomery Securities (now part of Bank of America). Like its well-known predecessor, the new investment bank and research firm concentrates heavily on high-technology sectors.
Earlier this week, we spoke to analyst Elias Moosa on what this new communications era is all about and what kinds of companies might lead the industry into this approaching Golden Age.
In your latest report, you say a new era in communications is set to emerge? What is this new era, and what's driving it?
Elias Moosa. Let's start with the Deregulation Act of 1996, which in turn has driven increased rivalry in the telecommunications market. The result has been newcomers like Qwest Communications (QWST: news, msgs) and companies like Rhythm NetConnections (RTHM: news, msgs) that are rivaling incumbents such as U S West and AT&T. In turn, companies like AT&T (T: news, msgs) have tried to rival companies like Bell Atlantic (BEL: news, msgs). So everybody's getting into everybody's market.
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All these companies have been using new technologies to do that, which have upgraded in many cases the capabilities of their networks. This is what we mean by the new services, for instance connecting to the Internet at speeds that are 100 times faster than your current connections. Or delivering e-mail messages that have voice attachments, or even in the future, video attachments. These are the types of new services that are going to become possible as the very large carriers invest billions of dollars to compete with each other.
I'm calling this the 'Convergence Era.' This Convergence Era really tries to capture the concept of using one connection, one network, to deliver data, voice and video. Previously, we've had separate networks for them.
Your view that the 1996 federal law to deregulate the telecom sector helped bring about this emerging era runs contrary to popular wisdom in the nation's capitol, where many people consider the act a big disappointment.
Moosa. Until this year the consensus about the act was that it wasn't spurring the kind of competition it was intended to. The participants in the industry were finding loopholes and using delay tactics. If we take inventory in 1999, however, I would say we'll change our minds as to its success. The fact that we have seen a giant like AT&T in the telephone sector emerge as giant in the cable broadcast world as well is testimony to the success of the telecom act.
The result of that has been even further activity, by companies like Qwest which are trying to buy companies like U S West (USW: news, msgs), an old incumbent. These are the fruits of the telecom act that were not evident as late as last year, but this year are evident and have entered our thinking.
You cite public firms such as Ciena (CIEN: news, msgs), Juniper Networks (JNPR: news, msgs), Extreme (EXTR: news, msgs), Copper Mountain Networks (CMTN: news, msgs) and Clarent (CLRN: news, msgs) and private concerns like Sycamore Networks as example of companies that will help bring this new era into focus. Do any stand a chance of becoming the Convergence Era's Cisco?
Moosa. There are several rivals for that lofty title. Cisco (CSCO: news, msgs) itself should be considered one of the contenders for the King of the Convergence Era, or the New World Order. Several startup companies have a chance to reach that status. My guess is that the way they get there is by solving a very difficult problem. The ones that are solving difficult problems will probably see capital rush to them and will be able to have a very strong currency. And then will end up behaving like a consolidator in the industry, like Cisco did in the past 10 years. Cisco acquired often and early. That's really the secret to the next giant to emerge.
Already some of these companies have tapped the public market. Juniper's IPO was a phenomenon. They have the kind of currency now to consolidate more and more functionality within their company. They can present a kind of one-stop shop at some point to some of the carriers. I think that's the path toward reaching the lofty perch you describe.
Speaking of Cisco, how do they and the Lucents of the world fit in in this new era?
Moosa. The way the so-called telecom-era companies like Lucent (LU: news, msgs), Nortel (NT: news, msgs) and Alcatel (ALA: news, msgs) have attempted to position themselves is not much different than what Cisco did, except they are responding a little later. So they are paying a higher price for their acquisitions. They are looking at what functions and products they need to present to their customers and are really paying up for them. For instance Lucent recently bought a company called Nexabit, which is one of those Convergence-Era companies, for $900 million.
They also have a bigger transition ahead for them where they have to cycle out of businesses that are being displaced by these new technologies. Yet they have a great chance of contending in the New World Order just because of their deep pockets. They are children of regulation, had protected territories and businesses for decades and were able to amass great hoards of cash. And their equity currency remains powerful. I think they will end up absorbing Convergence-Era companies.
Are there any clear winners, or clear losers, heading into this New World Order of communications?
Moosa. No. It's too early to call clear winners or clear losers. There are companies with an advantage. Cisco, for instance, in the sense that they have great critical mass, an aggressive internal culture, they have been historically agnostic in terms of developing technology or acquiring it. They have a moving start.
Companies in the Telecom Era that are forward thinking and trying to make up lost ground also have a moving start. Companies like Lucent and Nortel have been both been pretty aggressive in making acquisitions and readjusting their businesses. Those three companies among current equipment suppliers probably have a better shot in the New World Order.
There are yet other private companies, for instance Avici in Massachusetts, which makes a very high-end switch that goes to the heart of a carrier's network. At some point they may be able to gather the same kind of currency and critical mass that Juniper is on its way to gathering. There are contenders among the Convergence-Era companies also.
Is bandwidth, like the long-distance business today, destined to become commoditized, and if so, what does that mean for pioneers in high-speed networks, such as Qwest, as well as traditional carriers such as AT&T?
Moosa. In the long term bandwidth has to be commoditized. That's not necessarily a bad thing for carriers. If they do deploy technologies that allow them to reach massive scale and massive capacity levels, they'll be able to deliver very cheap bits, bandwidth, and that will attract great volume.
Where carriers will then earn premiums will be in delivering so-called enriched media services. To deliver, for instance, a calendar function for you and I that contains all of our messages, all of our appointments, looks for events we might be interested in on the Internet. We'll check it everyday. We may end up subscribing to it. It'll be an entirely new kind of service for a carrier and an entirely new type of revenue stream. They are one of the hundreds and hundreds of services that may emerge once we get the broadband pipes to our homes.
Obviously, if companies are to come to rely on e-commerce as an essential way of doing business they cannot afford the interruptions that afflict the Internet today. How long do you think it will take before technology is developed and deployed to make e-commerce as secure and reliable as the traditional manner in which companies conduct business?
Moosa. This really strikes at the heart of companies using networks as a revenue- and profit-producing asset rather than as a cost center. We've really looked at private networks as a cost center; we use it to connect it to the printer, we use it to e-mail our colleagues, and to be more efficient, not to sell products and earn revenue and profits. But you're right. If you want to end up selling products you need to be reliable.
The technology that makes the Internet reliable and integrates it well into our own private networks is already starting to be deployed. For instance, there are companies today that are delivering solutions to balance the load on a web site. Frequently that's been why web sites go down. When you get swamped with traffic, you don't have the kind of equipment that is able to distinguish intelligently between the kind of traffic that goes to server A or server B, and it ends up swamping all the servers. Those types of technologies are now arriving on the market. I am going to guess that within two or three years we'll have the traffic management and security technologies well deployed to deliver reliable and robust commercial-grade Internet.
Aside from the companies we've mentioned, are there any others out there that Thomas Weisel believes are well positioned to succeed?
Moosa. I think investors should also focus on the component suppliers and subcomponent suppliers to the equipment companies. A lot of times these are really "enabling" companies. We like companies like PMC–Sierra (PMCS: news, msgs), a chip maker that delivers some of the very high-end solutions used by companies like Cisco, Lucent and Nortel.
We are also recommending Uniphase (UNPH: news, msgs), which makes optical components and subsystems, as broadband pipes need to be aggregated into very large fiber-optic trunks. Uniphase is really central to companies deploying optical systems. We encourage investors to look beyond just the system companies to some of the enabling companies. |
