For those interested, the complete Morgan Stanley Dean Witter "outperform" coverage analysis:
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Newbridge Networks (NN): OUTPERFORM
The Last IP/ATM Pure-Play Alkesh Shah/David Jackson – 8/31/99
52-Wk Sh EPS EPS EPS EPS EPS EPS 5-Yr Est.
Price Rng Div Yld (MM) F99A F00E P/E F01E P/E C98A C99E P/E C00E P/E Growth
27 40 - 15 -- -- 182.5 $0.61 $0.98 28 $1.38 20 $0.61 $0.77 35 $1.33 20 30%
Fiscal year ends in April.
We have initiated coverage of Newbridge Networks with an
Outperform rating and a target price of $36, 27 times our
C2000 earnings estimate of $1.33 per share. The company
missed consensus estimates a number of times over the past
12 months and is now rebuilding credibility with investors.
We believe that management is solving the production
problems that hindered growth and is beginning to articulate
a clear strategy for diversifying into Internet protocol-based
products. However, we expect that multiple expansion will
occur only with more consistent revenue and earnings growth.
With the recent acquisition of Ascend Communications by
Lucent Technologies (LU, $64, Strong Buy, target $85),
Newbridge Networks is the last asynchronous transfer mode
(ATM) pure-play for investors. Its key product — the
MainStreetXpress 36170 Multiservice Switch — accounts
for the majority of its sales and provides its fastest-growing
revenue stream. It is designed to carry diverse forms of
traffic, including voice, data, and video, with appropriate
quality of service. Newbridge is diversifying into
broadband access products and equipment to provide man-aged
Internet protocol (IP) services, but we expect most of
its revenues to come from its core ATM business for the
foreseeable future.
Investment Positives
Focus on rapidly growing market. As carriers move to
packet networks and expand bandwidth in the local loop,
demand for ATM and IP-based switching and network man-agement
equipment is growing rapidly. We estimate that
growth in the market for enterprise, edge, and core ATM
switches is currently more than 40% per year and should
continue at that rate for the next few years.
Pure data-networking play. Newbridge Networks offers
a pure-play opportunity to invest in the data networking
space. Industry consolidation has shrunk the number of
pure-play data-networking companies sharply over the last
few years, as traditional providers of circuit-switched
equipment acquired providers of ATM and IP equipment.
Strong market position. Industry analysts estimate that
Newbridge holds a significant share in the wide area net-work
(WAN) and core ATM switch worldwide markets.
The Yankee Group and International Data Corp. agree that
Newbridge leads the ATM edge and enterprise switch mar-ket
with more than a 26% share. In the worldwide multi-service
backbone switch market, the Gartner Group esti-mates
that Newbridge held fourth place by share in 1998.
Newbridge's share was 18.5%, behind Nortel Networks
(NT, $43, Outperform, target $50) with 23.6%, Lucent/
Ascend with 27.0%, and Cisco Systems (CSCO, $67, rated
Strong Buy by Chris DePuy, target $75) with 28.1%.
Global, diversified customer base. MainStreetXpress
products have been chosen for deployment by carriers glob-ally.
Recent contracts for Newbridge equipment include the
ACTEW Corp. (Australia, April 1999), the Bulgaria Tele-communications
Co. (March 1999), Cable and Wireless
(March 1999), Global One (March 1999), and the Zenzhou
Telecommunications Bureau (China, March 1999).
Newbridge Networks
Stock Price Analysis
TECHNICAL VIEW (Philip J. Roth)
Support Resistance Next Resistance Medium-Term Trend
23 – 24 29 – 30 35 – 36
Award-winning products. Newbridge's products are re-garded
as cutting-edge. Carrier Scale Internetworking
(CSI), an open standards-based solutions framework devel-oped
by Newbridge and 3Com that enables service provid-ers
to deliver scalable, reliable, and easy-to-manage IP
VPNs over a multiservice ATM infrastructure, was praised
by the Yankee Group for lower total cost of ownership than
competing solutions. Data Communications Magazine
awarded its Testers' Award to Newbridge in March 1999 for
the MainStreetXpress 32170's frame-relay-to-ATM-Internet
working capabilities.
Siemens relationship strengthens Newbridge's competi-tive
position. Siemens and Newbridge formed an alliance
in March 1996 under which Siemens sells Newbridge prod-ucts
primarily to telecommunications carriers in Europe,
Latin America, Asia, and North America, and co-brands the
MainStreetXpress products with its own name. Siemens
provides marketing and support and allows Newbridge to
penetrate customers looking for a broad product offering
with the backing of a major diversified equipment provider.
Strong software content should maintain margins. We
believe that sophisticated network management will become
increasingly important, as single networks are used to carry
voice, data, and multimedia to different types of end-customers.
Investment Risks
Inconsistent results have depressed NN's multiple and
impaired the company's credibility. Recent misses were
due to poorer-than-expected performance in Newbridge's
traditional time-division multiplexing (TDM) business and
the inability to raise production at short notice. In the last
quarter, the TDM business represented only 28% of total
revenue. While Newbridge beat consensus estimates by $0.02
in the latest reported quarter (April), we believe that it has some
way to go before investor confidence is fully restored.
Reliance on Siemens relationship. During the quarter
ended January 31, 1999, 20% of Newbridge's sales were to
Siemens, up from 16% a year earlier. For the nine-month
period ended January 1999, sales to Siemens accounted for
16% of Newbridge's sales, down from 19% in the same
period a year earlier.
Declining revenues from enterprise and circuit-switched
products. Newbridge's circuit-switched TDM business is
declining as service operators move to packet-switched networks.
Industry consolidation has strengthened Newbridge's
competitors. Providers of packet switching have been ac-quired
by larger telecommunication equipment suppliers.
They are consequently able to provide end-to-end solutions,
including ATM switching, optical backbone products, and
access solutions. Moreover, an increasing number of serv-ice
providers require vendor financing, which Newbridge's
larger competitors are able to provide.
Consolidation may disrupt Newbridge's OEM channels.
In addition to Siemens, Newbridge products are distributed
by Alcatel (ALA, $31, rated Strong Buy by Angela Dean
and Gareth Price Jones, target $35), Lucent, Cable & Wire-less,
Nippon Telegraph & Telephone (NTT, $57, rated Out-perform
by Paul Saferstein), and other telecommunications
equipment suppliers. Diversified equipment providers are
striving to offer a range of products that satisfy all the needs
of their operator customers. This has led to consolidation
within the telecommunications equipment industry, marked
by a series of mergers during the last 18 months. The pur-chase
of data networking companies and product portfolios
by telecommunications equipment providers reduces their
incentive to distribute equipment from competing providers.
We expect continued data networking acquisitions by tele-communications
equipment providers.
IP will ultimately displace ATM. ATM is currently the
technology of choice for value-added high-bandwidth serv-ices
and multiservice networks that carry both voice and
data. However, enhancements to Internet protocol should
allow IP to offer robust quality of service. The intrinsic
benefits of Internet protocol, particularly its ability to cross
networks with different Layer 2 architectures, mean that IP
is likely to displace ATM as the technology of choice for
value-added, multiservice networks.
Revenues in Newbridge's January quarter might be im-paired
by enterprises slowing spending due to Y2K is-sues.
While the company states that it has seen no evidence
of an impending Y2K-related slowdown in aggregate de-mand,
we still believe that this possibility remains a risk.
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