Harmonic is Individual Investor's stock of the day...
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Harmonic: Broadband Class Act
Senior Analyst: Luciano Siracusano (2/28/00)
Harmonic Inc. (NASDAQ: HLIT - Quotes, News, Boards) stands at the crossroads of two powerful trends in the communications evolution: The rollout of broadband (high speed Internet connections) and the building of the fiber optics networks that will serve as the backbone of the information superhighway.
To understand why we believe Harmonic?s stock will outperform the market for the year ahead, we first need to look at the valuable role it plays in the cable industry. Afterall, its shares have swelled more than 12 times in the past year.
Cable networks were originally designed for the one-way transmission of broadcast video and, therefore, cable operators have been constrained in their ability to offer two-way digital services, such as high-speed Internet access and telephony (the conversion of analog signals into data packets for transmission over the Internet).
In order to reliably deliver interactive services to large numbers of subscribers, cable networks need to deploy fiber closer to the subscriber and increase the amount of optical fiber and fiber optic equipment in a cable network.
This is where Harmonic enters the picture.
Harmonic designs and makes digital and fiber optic systems -- including optical transport solutions -- primarily devices that provide a ?return path? in hybrid fiber optic/coax cable lines. This technology enables information to flow in two directions over cable lines (e.g. both to and from a consumer's PC). Harmonic products take analog signals, digitize them, transmit them at high speeds, and then reconvert the digital information back into analog signals at the far end of the network.
These advanced solutions will enable cable television and other network operators to provide a range of interactive broadband services that include high-speed Internet access, telephony and video-on-demand.
By becoming the first company to deploy a dense wave division multiplexing (DWDM) system for cable operators, Harmonic is dramatically increasing the bandwidth capacity needed for two-way communication. The company?s DWDM solutions help cable operators save money by mitigating the need to lay more fiber, buy more real estate or spend more on maintenance.
By making scaleable optical nodes (an advanced optical receiver placed closer to the end user), Harmonic also gives cable operators the option of starting with a minimum investment and adding incrementally to their network capability as subscriber demand grows.
Harmonic, which sells to customers like AT&T (NYSE: T - Quotes, News, Boards), Time Warner (NYSE: TWX - Quotes, News, Boards) Cox Communications (NYSE: COX - Quotes, News, Boards) and Charter Communications (NASDAQ: CHTR - Quotes, News, Boards), reported 1999 sales of $184.1 million ($63.3 million in the fourth quarter) and earnings of $0.76 per diluted share. This compares to a loss of $0.92 in 1998.
In its most recent quarter, it increased its per share net by 1550%, earning $0.33 versus $0.02 a year ago.
Domestic demand continues to drive growth. Domestic sales tripled and kicked in 73% of the fourth-quarter total. AT&T remains Harmonic?s largest customer (41% of revenue), but the company saw sales to its other clients, including RCN, Cox and Charter, increase more than 72% sequentially from the third quarter, suggesting that Harmonic?s market share is growing throughout the industry.
Higher unit volume is helping to push gross margins above 46%, while cost controls lifted operating margins to 21.3% in the December quarter.
The company?s balance sheet remains strong, with nearly $90 million in cash and short-term investments and no debt.
Acquisition of Divicom
Harmonic?s ambition is to become the leading provider of digital solutions for the delivery of video, voice and data over a wide range of broadband networks beyond just cable itself. This is one of the reasons why Harmonic recently entered into a definitive agreement to acquire Divicom, a division of C-Cube Microsystems (NASDAQ: CUBE - Quotes, News, Boards).
Divicom develops digital video broadcasting systems for satellite, wireless, cable and other emerging broadband markets. Specifically, Divicom designs Mpeg2 encoders that compress TV signals into digital form at a lower bit rate, meaning that more data can be transported over cable networks, augmenting Harmonic?s plans to offer video-on-demand and other broadband solutions.
The $1.7 billion Divicom acquisition, scheduled to close by April, will roughly double the size of Harmonic. The merger will also broaden its global reach as Divicom sells to such customers as ExpressVu, Lin Television, Telefonica (NYSE: TEF - Quotes, News, Boards), Telenor, Telia, and US West (NYSE: USW - Quotes, News, Boards).
Harmonic remains attractive on a relative valuation basis to other players in the sector. On Friday, its stock closed at $131.38, up $2.25. This is just off of its high. In the past year you could have bought the stock for as low as $10.56 a pop.
With new highs being made by the stocks of its fiber-optic brethren, including companies like JDS Uniphase (NASDAQ: JDSU - Quotes, News, Boards), Corning (NYSE: GLW - Quotes, News, Boards), SDL (NASDAQ: SDLI - Quotes, News, Boards), Ciena (NASDAQ: CIEN - Quotes, News, Boards) NetOptix (NASDAQ: OPTX - Quotes, News, Boards) and Digital Lightwave, (NASDAQ: DIGL - Quotes, News, Boards), we see no reason why Harmonic shares should not go considerably higher from here.
Bottom Line:
Harmonic is coming off a very strong quarter. With the acquisition of Divicom, scheduled to close by April, Harmonic is as well positioned as any mid-cap company to benefit from the accelerating rollout of broadband. It remains one of our top picks within the fiber optics sector.
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