SDLI - $275 price target by JP Morgan
6-Dec-99 J.P. Morgan (WILLHOIT, CHARLES (1-415) 954-9378) SDLI
SDL, INC.: CONTINUED BULLISH SENTIMENT FOLLOWING MANAGEMENT MEETING
CONTINUED BULLISH SENTIMENT FOLLOWING MANAGEMENT MEETING
UPGRADING 12-MONTH TARGET PRICE TO $275; INCREASING 2001 EPS ESTIMATES
We are raising our target price for SDLI from an outdated $125 to $275
and increasing our 2001 EPS estimate from $1.69 to $1.77 Following our meeting with management late last week, we continue to believe that SDL's
business fundamentals are very strong as demand for its technically
superior pump laser products and its new 10 Gbps modulators continues to
outstrip supply. The submarine business, which made up 25% of the
company's sales last quarter, is expected to be more than 30% of sales in
the fourth quarter as the second customer ramps its orders. Submarine
sales, which should increase throughout 2000, particularly if a third
customer which has already qualified the company's products begins to take
product, should help the SDL continue its strengthening financial
performance as submarine products sell for two to three times that of
their terrestrial counterparts. We continue to believe that SDL has
significant leverage in its model, with top-line, gross margin, and
operating margin expansion potential. We expect SDL to make several
acquisitions in the coming year to expand its product offerings and to
introduce several new products that are being developed in-house. We
believe that SDL has a strong fundamental position in the optical
components industry selling into the sweet spot of the market with its
expertise in active components. Our current revenue and EPS estimates may
very well prove conservative over the next 24 months and as such, we
continue to believe that SDL represents a good investment opportunity for
investors looking to benefit from the growth in optical networking.
We reiterate our BUY rating on shares of SDL.Target Price and Valuation
We are raising our target price for SDLI to $275, representing about 50%
appreciation over current levels. Our new target price is calculated
multiplying a 25 times forward revenue multiple to our 2001 revenue
estimate of about $407 million. SDLI is currently trading at 24 times our
2000 revenue estimate of $283 million. We are not concerned about these
multiples, as we believe that the company has a significant opportunity to
surpass our estimates. Our revised financial projections assume just
55% revenue growth in 2000 and 44% revenue growth in 2001, conservative
numbers in our opinion given the current and expected demand dynamics over
the nest two to three years. Our estimates also do not include any
potential acquisitions, most of which the company believes would be
accretive to earnings. Like its peers, SDL is selling into a market where
demand is far outstripping supply and new communications related
developments and markets, like longer transmissions without electrical
regeneration (which created more demand for pump lasers), intelligent
optical networking, and the potentially sizable market for metro based
optical networking applications should continue to boost growth in the
optical components market in 2001 and beyond. Given the current and
expected demand scenario and the fact that barriers to entry in this
market are very high, we expect SDL to meet or likely exceed our current
revenue and earnings estimates.
Our new 2001 EPS estimates account for slightly more optimistic revenue
and gross margin assumptions, although we expect to have to increase our
2000 EPS estimates following what should be another successful fourth
quarter for SDL. Our new 2001 EPS estimate of $1.77 assumes revenue
growth of 44%, reaching $407 million, gross margins of 47%, and operating
margins of 23.5%. We believe that all of these estimates could very well
prove conservative. Our new 2000 and 2001 EPS estimates represent 71% and
41% annual growth rates.JPMS Fiscal EPS Estimates for SDLI
4Q99E FY99E 1Q00E 2Q00E 3Q00E 4Q00E FY00E FY01E
Revised EPS $0.25 $0.73 $0.27 $0.30 $0.33 $0.36 $1.26 $1.77
Estimates
Previous EPS $0.25 $0.73 $0.27 $0.30 $0.33 $0.36 $1.26 $1.69
EstimatesSeveral Points from our Management Meeting
£ SDL is sounding like a maturing company focused not only on shorter-
term sales growth, but also on longer-term positioning. It is easy to
look at SDL as a two product company, but management insists that its
internal capabilities for building key passive technologies like fiber
Bragg gratings and its ability to package products will allow the company
to be very successful in an environment where customers are asking for
more integrated products. Management talked quite a bit about internal
developments for next generation enabling optical technologies and stated
that it is actively looking at acquisitions as a means of boosting its
product offerings and its capacity. We are excited to hear SDL talk
about its plans for the future as opposed to simply talking about selling
point products, like pump lasers or modulators.
The company actually laid out a four step plan for growth:
£ Step 1: Leverage Technology Leadership - This is obviously
dominated by its core strength in pump laser technology, including its
power advantages and is packaging capabilities.
£ Step 2: Increase Manufacturing Capabilities - SDL has expanded
its telecom related capacity 10X in the last 12 months with goals to
continue to aggressively expand capacity and improve yields.
£ Step 3: Develop and Expand Customer Relationships - SDL is
working on developing and expanding customer relationships across the long-
haul terrestrial, submarine, cable, and metro markets. For the first
time, we heard the company talk about longer-term, more encompassing
supply contracts as a goal. We believe that this is a sign that SDL is
now focusing more attention on being a longer-term market winner. SDL has
already received a four year exclusive contract from Alcatel
(ALA/BUY/$43.00) for is submarine pump lasers and a three year contract
(non-exclusive) from its second (unannounced) submarine customer.
£ Acquire Critical Technologies - The IOC acquisition (modulators)
is a sign of more things to come at SDL. Armed with cash from a recent
follow-on offering and a valuable stock currency, we expect SDL to make
multiple strategic acquisitions in the coming year.
£ While the terrestrial business continues to dominate SDL's sales,
the submarine business looks very strong. Submarine sales should turn in
another solid quarter in December, representing more than 30% of the
company's total sales. This is up from 0% of sales in 3Q98 and 25% last
quarter. A strong submarine business may again prove our gross margin
estimate conservative as submarine products command a price that is two to
three times that of terrestrial based products. SDL expects two
significant submarine customers in the quarter and possibly orders from a
third in 1Q00.£ We believe that SDL has significant room for financial
improvement. We estimate that most pure plays in optical components will
likely have a longer-term model of about 50% gross margins and 25% -30%
operating margins. Peers like JDS Uniphase (JDSU/$251.19/Buy) and E-TEK
(ETEK/93.38/Buy) are currently operating near this model, but SDL
continues to lag behind, mostly because of legacy businesses still
representing about 25% of sales. In the latest quarter, SDL had 43.9%
gross margins and 18.7% operating margins. Our current financial
projections have SDL reaching nearly a 48% gross margin and a 24%
operating margin by the end of 2001 - very conservative estimates given
the recent performance of the company and the demand prospects for the
coming years. The company's operating leverage is mostly in the SG&A line
where about $500,000 of expenses were incurred over the last several
quarters for consultants working on an ERP implementation which is now
nearly complete. This should drive SG&A down from 13.7% of sales to a 12%-
13% number in 2000.
£ Demand for 10 Gbps modulators, acquired from IOC earlier this
year, is very strong. The company's guidance is for a 400% increase in
sales in 2000 (albeit from a relatively small base of about $10 million in
1999), but this performance would only satisfy the demand from one
customer. We think that there are eight or ten more customers that want
to buy products from SDL and we expect the company to ramp capacity for 10
Gbps modulators as fast as possible, likely surpassing the 400% goal.
Customers are now asking for 10 Gbps modulators at an equal pace to that
of the more heavily supplied 2.5 Gbps modulators.
£ SDL has a number of new products that are expected to come to market
in 2000. Raman amplifiers, used to amplify light in shorter distance
networks or augment the amplification of larger optical amplifiers, are
likely to generate about $5 million of revenues in 2000. These products
may have a significant opportunity for deployment in metro markets where
smaller amplifiers are likely to be a key piece of shorter distance,
highly flexible optical networks. SDL is also working on more integrated
optical amplifier modules, higher power pump lasers, ramping its 10 Gbps
modulators, and has projects for products like tunable lasers, and other
future enabling optical technologies.
(J.P. Morgan Securities Inc. acted as co- or lead-manager in an offering
of securities for ALA within the past three years.)
First Call Corporation, a Thomson Financial company.
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