Com21: Undiscovered Broadband Play
TODAY
INDIVIDUAL
INVESTOR
ANALYSIS
individualinvestor.com
Senior Analyst: Garrett Bekker (2/25/00)
Back in June of 1999, cable modem providers Com21 (NASDAQ: CMTO - Quotes,
News, Boards) and Terayon (NASDAQ: TERN - Quotes, News, Boards) were so
similar that choosing between the two was nearly impossible.
As it turned out, Terayon became a stock market darling in recent months, rising nearly
five-fold from around $50 per share to over $250.
Com21, meanwhile, hasn't had nearly as much success. The company languished
during the summer months, largely because its cable-modem technology failed to pass
key certification tests. The net result was that the company's shares lost nearly
two-thirds of their value, falling from a high in the mid-$30s back in the spring of 1999 to
a low of $13.25 on October 29.
However, the stock has done well recently, rising 145% to $48.38 since closing at
$19.75 on January 7. Yet, we think Com21's shares could get even hotter.
Com21 is a provider of cable modems, head-ends and integrated network management
software that allow cable operators and service providers to deliver high-speed,
cost-effective Internet and telephony applications over cable. While cable modems
reside on a home user's PC, head-ends reside at the other end of the cable connection
at the cable provider's facilities. In combination, the two products allow for the fast,
reliable high-speed Internet and cable transmission that is becoming increasingly
popular.
Com21 customers include Charter Communications (NASDAQ: CHTR - Quotes, News,
Boards), Cox Communications (NYSE: COX - Quotes, News, Boards), Prime Cable,
Philips (NYSE: PHG - Quotes, News, Boards), Siemens and AT&T's (NYSE: T -
Quotes, News, Boards) Tele-Communications, Inc.
Com21's Community Access system allows cable operators to offer up to 16 different
transmission rates, which allow broadband service providers to offer residential and
business customers different levels of service at various price points. Com21's system
can be upgraded and scaled as subscribers grow, and is also designed to support cable
telephony.
Com21 also announced last summer that it would utilize its broadband-over-cable
technology to offer wireless telecommunications services. The company has already
completed limited trials in which two-way, high-speed data access was conducted over
a 20-mile radius.
Growth of high-speed Internet access and Internet-based telephony is perhaps reason
enough to like the shares of any company competing in this space. High-speed or
broadband access is one of the most exciting areas on the Internet, since it will permit
the transmission of streaming audio and video and usher in true interactivity.
Today the majority of Internet surfers connect via telephone modems at speeds no more
than 56,000 bits per second. By 2002, however, Forrester Research predicts the
number of U.S. homes with high speed Internet access will increase from
500,000 in 1998 to 16 million, or 26% of total U.S Internet users.
Anyone who has witnessed Terayon's recent performance is well aware of this potential.
However, our main reason for recommending Com21 is that we think that there is an
enormous valuation disparity between these two companies that isn't justified, given
how close we think they are.
Analysts on The Street are calling for Terayon to generate roughly $235.2 million in
revenue during 2000. With 31.5 million shares outstanding and a current price of $259,
this translates into a price-to-sales multiple of 34.7.
Com21, on the other hand, is expected to generate $163.5 million in revenue, and with a
market-capitalization of $997.1 million, provides a price-to-sales ratio of just 6.1. This is
a Huge discount to Terayon, and in our opinion this gap should narrow substantially.
Com21's current price-to-sales multiple is slightly more than one-sixth that of Terayon.
Given the similarity of these two companies, we think further contraction in the valuation
gap is quite reasonable. If Com21's multiple were to expand to one-third of Terayon's, or
11.6 times, this would translate into a price of $88, a premium of 83% to its current
price of $48.38. If we want to get a bit more daring and assume that Com21's
price-to-sales multiple could expand to one-half that of Terayon's, or 17.4 times sales,
this would lead to a price of $132, a premium of 173% to its current price.
On what basis do we think Com21 is comparable to Terayon? For the fourth quarter
ended December 31, Joel Achramowicz of Preferred Capital Markets estimates that
Com21 generated roughly $24.8 million in revenue from cable modems, versus $27.6
million for Terayon. This is consistent with market projections from the Dell'Oro Group,
which estimated that Com21 had 12.5% of the cable-modem market in the December
1999 quarter, while Terayon had 12.9%.
In head-end systems, Terayon had nearly twice the market share of Com21 (8.9%
versus 4.5%). However, Com21 generated $4.7 million in head-end revenue versus $5.6
million for Terayon, as higher unit prices for Com21 largely offset lower unit volume.
Another reason to like Com21 is that the company was ranked No. 1 in European cable
modems in 1998 by market research firm Ryan Hankin Kent, and named the third
largest supplier of cable modem technology worldwide, based on independent studies
by GartnerGroup/Dataquest, The Dell'Oro Group, and Cahners In-Stat Research Group.
While Internet usage by Western European households still trails the U.S., the potential
for growth is enormous. The number of European households and businesses
connected to the Internet doubled in 1998, rising from 5% to 10%, and is expected to
reach 17% by the end of 1999.
Granted, we should point out that Terayon has made a number of acquisitions in recent
months that were intended to move Terayon beyond just being a pure-play cable modem
provider and move into other areas such as xDSL transmission, broadband video
switching and computer telephony. This has certainly been a catalyst behind the
meteoric rise of its share price.
Bottom Line:
While we might accept the argument that Terayon deserves a premium multiple
based on these acquisitions, we don't see any clear reason why it should be
worth nearly six times as much as Com21. Accordingly, we think more catching
up is in order. |
