need a dose of sell-side to alleviate your near-term ailments?
here are excerpts from levy's latest (lehman bros) dubbed
"Objective Views Through the Cross Currents" (dated 27 aug 99).
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Objective Views of Tellabs:
For the past decade we have been one of the biggest believers in Tellabs?
addressable business opportunities and have been recommending its stock
almost unbrokenly. While it is clear that (1) the stock has been one of the
biggest winners of the 1990s and (2) its financial performance and prospects
have been and remain outstanding, it seems like a good time to objectively
review the company?s situation and the stock?s valuation. Our conclusions
detailed below, lead us to believe that the outlook for Tellabs remains
excellent, that there is still plenty of upside in TLAB shares, even between
now and the end of the year, and thus we are strongly reiterating our 1-Buy
rating and $85 target price.
There seem to be many cross-currents driving Tellabs? stock lately, not the
least of which was yesterday?s announcements by Cisco that it is acquiring
Cerent Corporation and Monterey Networks, which some people interpreted as
negative for the company?s digital cross connect business and drove the stock
down more than $5, or approximately 8%. On the positive side, a few days
ago, speculation that Tellabs would win two high-profile pieces of business
with AT&T and Williams drove the stock up. While we think that almost all of
these stories and events are almost certain to be immaterial when it comes to
financial performance -- i.e. revenues and earnings forecasts are not likely to
change -- they do have real impacts on the stock. Thus we have tried to
present, as best as we can guess, what these cross-currents are and how they
might or might not impact Tellabs as a company and TLAB shares.
First The Negatives.
* For the first time in many years there are new venture-backed startups
aimed at Tellabs core transmission system business. Companies such as
Lightera (acquired by CIENA), Monterey (about to be acquired by Cisco), and
Cerent (also about to be acquired by Cisco) have been created in order to
ride the wave of demand for higher and higher bandwidth networks being built
by carriers around the world. No longer is Tellabs "the" David against
Lucent or Alcatel or Nortel?s "Goliath." The potential for "spin damage" as
these companies come public seems real.
* Specifically addressing the idea that Cerent and Monterey are competitive
with Tellabs? cross connect we can see how investors would view this as a
negative. Cerent clearly has the ability to nibble at the low-end of Tellabs
digital cross connect business while Monterey could be a threat at the high-end
of the soon to be released TITAN 6500. Where we think perception is
getting the better of reality is just how much of an incremental threat the
two products line are now that they are part of Cisco compared to them being
stand alone entities. The reality, in our opinion, is that Cerent sales to
date have been almost totally aimed at Lucent, Nortel, Alcatel, and Fujitsu?s
SONET add-drop multiplexer business and not at Tellabs? digital cross
connects. It is reasonable to assume that Cerent?s continued success could
bleed off some of the opportunities for Tellabs at the end-office, and in
particular with emerging carriers, but we do not see this as a material
problem. As to Monterey, the product is not expected to go into trials for a
few more months and it is way too early to say what kind of impact it can
have, in our opinion.
* One of Tellabs main product lines, the Martis DXX, continues to run behind
plan for reasons that are short term in nature and not reflective of end-user
demand, in our opinion. The combination of continued weakness of the Finnish
Krona versus the dollar, the persisting economic issues in the Asia Pacific
Region and reorganizations at Ericsson are likely to result in Martis sales
coming in below expectations again this quarter, likely around the $110
million level versus our $125 million forecast. This is clearly a
disappointing situation but far from lethal.
* The AN2100, one of Tellabs new products has not taken off as expected.
This product is an ATM Gateway and was initially designed for Sprint?s ION
network. Software issues in Sprint?s ION network, related to other equipment
vendors to Sprint, have caused an overall delay in the deployment of the new
network and thus the roll-out of additional AN2100 systems. We believe that
these software issues are likely to result in this new product contributing
only an immaterial amount to sales this year but becoming more significant
next year as Sprint?s roll-out accelerates and a general version of this
product becomes available for other customers.
* One of Tellabs other new products, the TITAN 4500, is also late. This
TITAN product interfaces with both SDH and SONET connections and was expected
to start generating revenues around this time. Longer than expected sales
cycles, however, are likely to postpone these initial sales. Tellabs had
never expected much from the TITAN 4500 but the delays in initial revenues
are disappointing none-the-less.
* As we enter the new millennium Tellabs faces a more competitive digital
cross connect market. The company has been the leader of the pack throughout
the 1990s but the competition is planning to attack with full force as next
generation cross connects come into being. We believe the serious
competition is going to be from Alcatel - who has been in the race all along
- as well as CIENA through its Lightera acquisition and Cisco with its
acquisition of Monterey. In addition, Lucent and Nortel who were quiet
during the last decade of the cross connect business are not likely to miss
the boat again. These companies represent some of the most well-respected
and competitive firms in the telecommunications equipment market-space and
are likely to be formidable opponents.
And Now the Positives.
* There has been a lot of talk in the marketplace that SONET was going to
become a relic of the past as IP over wavelengths came into being and
displaced the need for SONET. We have not been part of this camp as we
believe the importance of the SONET layer in the network was not likely to be
displaced. In our opinion, Cisco?s acquisitions of Cerent and Monterey, with
their respective SONET elements, essentially endorses our long-held views.
Thus it could very prove out to be that SONET and digital cross connect
markets could expand even faster than anticipated. In fact, to the extent
that Cisco?s endorsement of SONET and digital cross connects increases the
growth rate of the market its should more than make up for any incremental
threat the two acquired companies pose under Cisco?s corporate umbrella. In
addition, new information out of a just completed study at the independent
research firm of Ryan, Henkin and Kent, RHK, shows that the SONET and digital
cross connect markets are already expanding faster than forecasted just seven
months ago and this was before yesterday?s announcements.
* Tellabs? flagship product, the TITAN 5500, continues to blow away
expectations! Demand for TITAN continues unabated which is not only good for
business today, but also tomorrow. TITAN?s installed base continues to
expand and this gives Tellabs a competitive edge versus the competition as
software upgrades are much easier than ripping out existing product and
installing new systems - the steps that are going to be necessary with the
next generation products from the list of competitors mentioned above.
Another benefit of the robust demand for TITAN is that it should more than
offset any weakness from the other product lines - for example Martis sales
which were disappointing last quarter are expected to be below expectations
again this quarter. In addition to TITAN sales tracking well ahead of plan,
Tellabs? other main product line, its network enhancement technology systems,
NETS, is also poised to beat its numbers, as it did in the first half this
year and all of last year.
* The company?s most important new product, the TITAN 6500 next generation
digital cross connect is looking great. The development of this product in
on track and we expect trials to begin in the fourth quarter. This is
Tellabs? next big system and is quite complimentary to the TITAN 5500. We
expect revenues from this product to begin to be recognized early next year
and to ramp up quickly.
* New contract wins for a new acquisition -- Tellabs announced in late June
the plan to acquire NetCore Systems with its "Everest" integrated IP router /
ATM switch. Recent speculation has surfaced, with a good basis in our view,
that NetCore is likely to win some business from Williams, an aggressive
service provider committed to building its network with next-generation
technology systems. This win, if it were to be confirmed would be a boost
for Tellabs for two reasons: (1) it would justify Tellabs? entry into the
high-speed data switching business and make the recent acquisition more
attractive financially, (2) it would add another leg to the Tellabs stool,
and (3) it positions Tellabs as a more complete next generation solutions
supplier.
* Without any major new contract announcements, Cablespan, Tellabs? cable
telephony system is tracking ahead of plan and there has been some recent
speculation that the company seems likely to win the second supplier position
at AT&T. We have not factored any AT&T sales into our Cablespan forecasts of
$75 million this year and $158 million next year so any wins at AT&T could
provide upside to our current forecasts. In other words, Tellabs is building
yet another strong led [sic] to its stool.
* Overall near-term results are at or better than expected, once again.
Every indication we are receiving suggests that this quarter should be
another great one as robust sales of the TITAN 5500, the NETS echo cancellers
product lines, and Cablespan more than offset weakness in Martis sales
levels. We continue to forecast third quarter revenues of $587 million, up
39% year-over-year, and EPS of $0.34, a yearly gain of 36%, but believe that
Tellabs is well positioned to exceed these forecasts.
In summary, while we understand the cross currents that have been driving
TLAB shares up and down over the past week, and can see how investors would
be concerned about some of the issues, it appears that the negatives have
been overemphasized and the stock has unfairly punished. Tellabs continues
to look to us like a company with an excellent and defensible long-term
position in an exciting market with growth prospects of 30% annual earnings
growth for the next few years. At only 37 times next year?s EPS projections,
and with real upside potential we believe that TLAB shares should be bought
today as they could rise as high as $85 as these cross currents die down. |
