HLIT articles.......
Posted 10/1/99
Company Focus
Harmonic's stock soars on cable's need for
speed
This company's fiber-optic products are in hot demand by cable operators, and
its stock, up tenfold since January, is a hit with investors.
By Michael Brush
True or false: One day consumers really will go for a package of speedy
Internet access, interactive entertainment and phone service, all served up
through the cable connection into their homes. They'll want to dial up movies
on demand and pause them, say, if the phone rings. They'll want to read voice
mail or listen to their e-mail. They'll want to enjoy digital television.
If, like the people mapping out strategy at AT&T (T), you buy this scenario,
then take a closer look at Harmonic (HLIT). You may find the stock to be an
attractive bargain on dips. Harmonic makes products that help move more data
more quickly through the system of optical wires that bring cable signals to
your home. The company is riding high on the wave of capital spending by
cable operators scrambling to upgrade their networks.
Cable companies like Cox Communications (COX),
Comcast (CMCSK) and Time Warner (TWX) need
to develop "broadband" pipelines to your house
because their business has changed. They once
grew by adding new customers. Now, they have to
grow by selling the same customers new products.
This means things like faster Web access, interactive games or more TV channels so
they can compete with satellite broadcasters like Hughes Electronics' (GMH) DirecTV
and EchoStar Communications (DISH).
Better cable network with higher capacity
In addition to the traditional cable operators, AT&T is one of the big players making
a bet on broadband. It beefed up its cable presence last March by buying
Tele-Communications, and it is closing a deal with MediaOne Group (UMG). Among
all the other products that can go through cable, AT&T would like to be able to offer
you phone service without having to pay exorbitant fees to local phone companies to
get access to your home. But to bring you these goodies, AT&T and the cable
companies need a more-reliable cable network with higher capacity.
Enter Harmonic. Its most recent cash cow, known as METROLink, has been a huge
hit among cable operators because it does a good job of increasing the bandwidth of
fiber-optic lines. Cable companies are replacing old coaxial cable with fiber optics to
improve their networks, converting them to interactive, two-way systems with much
greater capacity. In the upgraded systems, data travels as pulses of light along
fiber-optic lines from sources at their central office (the "headend") to distributors
near your home ("nodes"). These nodes convert the light waves (photons, to you
science majors) into an electrical signal that can be sent through old-fashioned
coaxial wires directly into houses.
In addition to its fiber-optic transmitters and receivers, Harmonic also has a lineup of
other products which hold plenty of promise should broadband applications really
begin to catch on. Cable operators, for example, believe they will have to start serving
fewer homes per node once cables start to get congested. Doing so will make their
systems more reliable -- a good thing when pesky regulators are looking over your
shoulder judging how well you provide phone service.
Analysts believe sales of Harmonic's node, called PWRBlazer, will start increasing
next year, once greater popularity of cable modems and cable phone service threatens
to put a strain on cable systems. Greater interest in interactive, cable-based products
should boost demand for Harmonic's return path transmitters, as well. And another
product, called TranSend, probably will start being used more and more by cable
companies at the headend of their systems when demand for digital content
increases. TranSend collects the various types of satellite and ground feeds at the
headend, and translates them to a digital signal so they can be sent over the cable
network.
Related Sites
To learn more about
Harmonic, visit its Web site
or read this ZDNet story
about cable operators and
fiber optics. To stay up on
the latest in light waves,
check out Photonics
Online. And there's some
useful info on AT&T's
network at its Web site.
A pricey investment
Harmonic seems like a good way to invest in all these trends. But if you are
thinking about buying shares in the company, you need to consider several
potential negatives surrounding the stock. Chief among them: valuation. Having
moved up tenfold since the start of the year to around $135, Harmonic now
trades at about 90 times forward earnings. That's rich, since the company has
a long-term growth rate of only 30%.
But it doesn't worry some of Harmonic's bigger fans. Eric Efron, co-manager of
the USAA Aggressive Growth (USAUX) fund, isn't trimming his position at
these levels, even though he has plenty of profits to take because he has
owned the stock since it traded around $14.
Warburg Dillon Read analyst Anton Wahlman says the stock is still worth
buying at these levels because he thinks it will continue to outpace others in
the field. "Their revenue is growing almost 100% year over year and the bottom
line is growing even faster. This will moderate in the next couple of quarters,
but Harmonic will still be growing faster than any of its peers."
A related problem with Harmonic shares, however, is the big presence of
momentum investors in the stock. They have been attracted in part by the
aggressive increases in earnings estimates over the past few quarters. So if
you buy shares in Harmonic, be ready for some wild volatility. "At the first sniff
of trouble, the momentum investors will be out," says Efron. "The stock has
been so strong it would be natural to see some profit-taking if anything goes
wrong."
Competition heats up
Just what might go wrong? One cloud on the horizon is the slippage in
Harmonic's research and development spending, says Standard & Poor's
analyst Mark Basham. He thinks this may make the company vulnerable,
since brisk demand in Harmonic's field means that more competitors will start
showing up on its turf.
Details
Harmonic
key ratios
Price Ratios
Growth Rates
Profit Margins
"They have had their area kind of to themselves for the past two quarters
because they were first to the market with a product that was sufficiently
advanced for them to gain market share," says Basham. "But they are going to
have to spend big bucks to keep up with the players that are going to come
into the sector. It is clearly going to draw in the big boys."
Basham speculates that companies ranging from fresh start-ups to established
firms such as Lucent Technologies (LU), Ciena (CIEN), JDS Uniphase (JDSU)
and Scientific-Atlanta (SFA) soon could start offering Harmonic tougher
competition.
Robin Dickson, Harmonic's chief financial officer, says his company has been
trying to beef up staff and increase R&D spending, but labor markets are tight.
"There is a difficult hiring environment in the places where we do research and
development, in Silicon Valley and in Israel."
Conversion is only half-finished
Another big concern is excessive customer concentration. AT&T accounted for
a whopping 40% of sales in the second quarter, and that will probably go up to
50% this quarter. Investors often begin to get nervous when any single
customer accounts for more than 10% of sales. But Dickson says he wouldn't
want it any other way, given that AT&T has become such a force in building out
capacity in the cable industry.
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"I would rather be where we are -- with AT&T -- than not with AT&T, because
they represent a quarter or a third of the cable industry," says Dickson. "You
have to be there. You have to be a significant supplier to them. We also have
good relations with all the other major cable operators in this country."
Blaine Carroll, an analyst who covers Harmonic for SG Cowen, says he
expects AT&T business to remain strong for several quarters. What's more,
Carroll estimates that the cable industry's conversion to fiber-optic cable is still
only about half-finished. "The majority of the small- to mid-size operators are
still just beginning to upgrade," he says. This leaves plenty of room for more
demand for Harmonic's fiber-optic transmitters and receivers.
Meanwhile, there are signs that the AT&T-Harmonic connection will continue.
No one knows for sure, of course, whether the demand for interactive products
and phone services over cable eventually will pick up enough to burden the
system. But AT&T thinks it will, and to learn more about how to deal with that,
the company is running an experiment in Salt Lake City.
AT&T is testing how much it helps -- and how much it might really cost -- to
put fewer customers on a distributor node at the end of a fiber-optic cable. The
company making one of the nodes that AT&T is testing: Harmonic.
Harmonic Hits All The Right Notes
Instantly after Next Wave 100 Index component Harmonic Inc. (Nasdaq: HLIT) unveiled plans for
a 2-for-1 split on September 13, its shares jumped 4 1/2 points to $140.
By any measure, not a bad move. Maybe a little anti-climatic, however.
Why?
The Sunnyvale, CA-based company, now a rising star in the white-hot digital and fiber optic arena,
rocketed from a low of $8.56 to a high of $146.62 during the past 52 weeks.
On September 23, HLIT closed at $116.75--a gain of more than 1,200 percent from the year's
low. In fact, HLIT is among the top performing stocks in 1999 on all U.S. markets.
That's enough to make investors start the millenium celebration early.
Communications Revolution
Riding a major wave, Harmonic Inc. designs, manufactures and markets digital and fiber optic
systems that deliver video, voice and data services over cable, satellite and wireless networks.
Its products enable global communications companies like cable television and other network
operators to provide a range of broadcast and interactive broadband services that include
high-speed Internet access telephony and video on demand.
In January 1998, Harmonic acquired of New Media Communication Ltd., which later changed its
name to Harmonic Data Systems Ltd. This has permitted the expansion of Harmonic's product line
to include high-speed data delivery software and hardware.
Diverse Leadership
Harmonic, which was incorporated in 1988, and completed its IPO in May 1995, today boasts a
seasoned and dynamic management team.
Chief Executive Anthony Ley, who served 25 years with Schlumberger Ltd. prior to joining
Harmonic, heads the team. Ley's tenure with the diversified giant included five years at its subsidiary
Fairchild Semiconductor, where he was VP for research and Engineering until 1987.
When Schlumberger sold Fairchild to National, he consulted for the new company for one year
before joining the two founders of Harmonic. He has been running the 293-employee company since
November 1988.
Another key player is CFO Robin Dickson, who joined Harmonic in 1992 after stints with Deloitte
Haskins & Sells in Belgium, Raychem Corp. and the privately held San Jose-based semicon
company Vitelic.
Walking the Walk
This year has been an outstanding one for Harmonic. Sales soared 109% from $18.2 million in 2Q
1998 to $37.9 million in the second quarter of 1999.
For the six-month period, revenue jumped 98 percent from $34.4 million in the first six months of
1998 to $68.2 million in the corresponding period of 1999.
The substantial increases are attributable primarily to new products, including METRO Link
DWDM systems and PWR Blazer Scaleable Nodes, which began volume shipment during the
middle of 1998.
Some of the increases are also attributable to higher spending by domestic and international
customers.
During the second quarter of 1999, domestic sales increased by 147 percent, principally due to
increased shipments to AT&T.
AT&T represented 40 percent of net sales in 2Q 1999 compared to 9 percent of net sales in the
second quarter of 1998.
International sales increased 56 percent during the second quarter of 1999, primarily due to higher
shipments to Canada and Asia.
Sales to customers outside the U.S. in 1997, 1998 and the first half of 1999 represented 59 percent,
43 percent and 36 percent of net sales, respectively.
Harmonic expects that international sales will continue to represent a substantial portion of its net
sales for the foreseeable future.
International sales represented 31 percent of net sales in the second quarter of 1999 compared to
42 percent in the second quarter of 1998.
Moreover, gross profit increased from $6.7 million (37 percent of net sales) in the second quarter of
1998 to $16.0 million (42 percent of net sales) in the second quarter of 1999.
For the six month periods, gross profit increased from $11.8 million (34 percent of net sales) in the
first six months of 1998 to $28.4 million (42 percent of net sales) in the first six months of 1999.
Commitment to R&D
Harmonic Inc. increased its R&D expenditures from $3.2 million (18 percent of net sales) in the 2Q
1998 to $3.5 million (9 percent of net sales) in the second quarter of 1999.
For the six month periods, R&D expenses increased from $6.7 million (19 percent of net sales) in
1998 to $7.2 million (11 percent of net sales) in 1999.
These increases were partially offset by lower prototype material costs and higher amounts of grants
earned in Israel—by Harmonic's Israeli-based research facilities—which are netted against research
and development expenses.
The decreases in research and development expenses as a percentage of net sales were principally
attributable to increased net sales.
Harmonic anticipates that research and development expenses will continue to increase in absolute
dollars, although they may vary as a percentage of net sales.
Currently, the company holds 12 issued United States patents and 9 issued foreign patents, and has
a number of patent applications pending.
It maintains two research facilities in Israel with a total of approximately 60 employees. The
personnel at these facilities represent a significant portion of its research and development
operations.
Financial Strength
In April Harmonic Inc. completed a public offering for approximately $58.3 million. The company
also received $4.0 million from exercise of a warrant.
As of July 2, 1999, cash and short-term investments totaled $57.7 million, while long-term
investments were $16.1 million.
Cash from operations was approximately $2.3 million for the six months ended July 2, 1999
compared to $1.9 million for the six months ended July 3, 1998.
The increase is because the company recorded net income in the first six months of 1999 compared
to a net loss in 1998.
Reliance on Cable TV
Cable television operators, directly or indirectly, account for almost all of Harmonic's sales. The
company expects these sales will be the main driver in the future.
The demand for Harmonic's products depends largely on the size and timing of capital spending by
cable television operators for constructing, rebuilding or upgrading their systems.
These spending patterns are dependent on a variety of factors, including annual budget cycles, the
status of federal, local and foreign government regulation of telecommunications and television
broadcasting, overall demand for cable television services and the acceptance of new broadband
services.
Competitive pressures, including the availability of alternative video delivery technologies such as
satellite broadcasting also influence these spending patterns.
Potential Pitfall
The loss of AT&T or another key customer could adversely affect Harmonic. Historically, a
significant majority of its sales have been to a small number of customers.
More recently, sales to AT&T has accounted for an increasingly significant portion of Harmonic's
net sales.
Sales to its ten largest customers in 1997 and 1998, and the first half of 1999 accounted for
approximately 56 percent, 66 percent and 78 percent, respectively, of net sales.
In 2Q 1999 sales to AT&T represented approximately 40 percent of net sales compared to
approximately 22 percent in the prior three-quarters.
In addition, in 1998 sales to a Chinese distributor represented approximately 11 percent of net sales;
in the first half of 1999 sales to a Canadian distributor represented approximately 12 percent of net
sales.
Almost all sales are made on a purchase order basis. That is, none of Harmonic's customers has
entered into a long-term agreement to purchase its products.
Clearly, as a result, the loss of, or any reduction in orders from, a significant customer could harm
the company's business.
Competitive Arena
Today Harmonic faces many larger and more established competitors.
The market for cable television transmission equipment is extremely competitive and has been
characterized by rapid technological change.
Harmonic's current competitors include significantly larger corporations such as ADC
Telecommunications, ANTEC (a company owned in part by AT&T), General Instrument, Philips
and Scientific-Atlanta.
Additional competition could come from new entrants in the broadband communications equipment
market, such as Lucent Technologies.
Most of these companies are substantially larger and have greater financial, technical, marketing and
other resources, and are in a better position to withstand any significant reduction in capital spending
by cable television operators.
In addition, many of its competitors have more long standing and established relationships with
domestic and foreign cable television operators than Harmonic.
A further concern is that its competitors may bundle their products or incorporate functionality into
existing products in a way that discourages users from purchasing Harmonic's products.
Street Coverage
In addition to its standing as a component of the Next Wave 100 small-cap technology benchmark,
currently Harmonic is in the cross hairs of at least five major Wall Street brokerage houses.
Among the Street analysts who provide research coverage on Harmonic Inc. are those from CE
Unterberg Towbin and Soundview Securities, who maintain strong buys.
UBS Securities, SG Cowen & Company and CIBC Oppenheimer have buy ratings today.
HLIT has a market value near $2.0 billion, with about 15 million shares outstanding, and a float of
about 10.2 million shares.
At these levels, the P/E Ratio is in excess of 300, while it trades 13 times sales.
Investors have rewarded the company with a generous P/E ratio on the bet that the digital and fiber
optic area will explode. Judging from the recent pyrotechnics in the telecom sector—they might be
on to something.
posted 9/24/99 |
