from today's NYT:
April 13, 2000
Modem Company Growing in a Competitive Market
By ALEX BERENSON
The company has a hot new technology, ripe for hype, whose details are understood only by engineering experts. Its stock has tripled since October and is valued at about 40 times last year's sales -- despite losing more than one-quarter of its value Wednesday in a stomach-churning decline.
It is no wonder that short-sellers, who bet against companies they think are overvalued, believe they have found an easy target in Terayon Communication Systems, a company based in Santa Clara, Calif., that is in the hotly competitive business of making cable modems and other networking equipment. On Tuesday, a conference call conducted by Terayon executives to discuss first-quarter earnings turned into a surreal free-for-all as short-sellers using fake (and juvenile) names repeatedly attacked the company's honesty.
To be sure, Terayon is not a stock for the faint of heart. After soaring from below $50 in early November to a midday high of $285.25 in early March, the company's stock has plunged. It closed Wednesday at $119.75, down $43. But even after its recent decline, Terayon has a market valuation of almost $4 billion, not bad for a company that is less than a decade old and has never turned an annual profit.
Yet underneath the mud, Terayon is growing exceptionally fast and establishing itself as a leader in the market for advanced cable modems and other communications equipment. In 1997, Terayon had $2 million in sales. Last year, sales were about $90 million. Next year, the company's sales could top $500 million, according to Wall Street analysts who follow the company.
With growth like that in an environment where technology companies can go from start-ups to profitable giants in a decade, Terayon cannot be dismissed simply because it is young and losing money. This year, analysts expect that the company will be profitable on a cash basis for the first time, although several noncash charges will wipe out its bottom-line earnings.
On Tuesday, Terayon reported first-quarter sales of $59.3 million and profits of $1.9 million, or 6 cents a share, before one-time charges, up from sales of $15.9 million and a loss of $4.3 million a year earlier.
"There just aren't too many companies that have this kind of revenue momentum," said Steven D. Levy, a Lehman Bros. telecommunications equipment analyst, who calls Terayon a buy, his highest rating. "In a market where we're paying for growth, it is very reasonable that this stock has gone up as much as it has."
Terayon's main business is making cable modems, the boxes that enable consumers to connect to the Internet at very high speeds over standard cable lines. With Internet users looking for faster access to bandwidth-hogging music and multimedia applications, the cable modem market is exploding. Kinetic Strategies, a research firm based in Phoenix, estimates 15.9 million cable modems will be installed in North America by the end of 2003, up from 2 million today. Companies vying for a piece of the market include Broadcom, Nortel Networks, Motorola and even Cisco Systems, all much bigger than Terayon.
But Terayon supporters say the company has an edge over its competitors in the cable modem business, thanks to a superior technology. Most other companies use a method known as TDMA, or time division multiple access, to transmit data over cable lines, while Terayon uses S-CDMA, or synchronous code division multiple access.
Most analysts agree that CDMA offers better performance than TDMA. CDMA offers "greater capacity and far superior immunity to noise," the electrical interference that distorts data transmission, the Gilder Technology Report wrote in February. As a result, cable operators that use Terayon modems can offer high-speed Internet access to subscribers even over older cable systems that have not been upgraded at great expense.
But in what may be the biggest controversy surrounding Terayon, the company's detractors argue that Terayon and analysts friendly to it have overstated the advantage of Terayon's technology. The reason: Big cable companies have created a consortium called CableLabs that will certify that all new modems work interchangeably on a single standard, called DOCSIS. Most U.S. cable operators will buy modems only if they meet that standard, and so far CableLabs has not incorporated Terayon's CDMA technology into DOCSIS. In addition, any company that wants to qualify for DOCSIS must agree to license its technology to other modem suppliers without asking for royalties.
That locks Terayon in a neat Catch-22, critics of the company say. Terayon's technology advantage will not help it crack the crucial U.S. cable market -- unless it agrees to give up its advantage, for nothing. They note that Terayon has so far had little success winning customers among big U.S. cable operators.
"People who have bought this stock on the thought that the company will receive a royalty stream from other cable modem manufacturers may be sorely disappointed," said James Chanos, a well-known short seller who has bet on a decline in Terayon's stock. Short-sellers sell stock they have borrowed, hoping to buy it back later when its price has fallen.
But bullish analysts say that Chanos and other short-sellers have overplayed their hand on this crucial issue. Terayon already has a DOCSIS-certified modem that uses TDMA technology, and the company has a good chance of winning CableLabs approval in the near future for a modem that will use both CDMA and TDMA technology. More important, the company is establishing itself as a leader in the huge Asian cable market, having recently won important contracts in China and South Korea.
"The company will be successful whether or not they're in the U.S. standard. They're doing very well in Canada. They're doing very well in Asia," said Tim Long, a communications equipment analyst at Merrill Lynch. "We're just expecting phenomenal growth." Long rates Terayon a short- and long-term buy.
In addition, bullish analysts argue that Terayon is copying Cisco's very successful strategy of using highly valued stock for strategic acquisitions. Terayon's cable modems are only one part of a nine-pronged strategy that will eventually include data, voice and multimedia transmission equipment over wireless, cable systems and phone lines.
"They've gone from being a middle-of-the-pack cable modem company to having a nice suite of products," said Ned Brines, manager of the $850 million Phoenix Engemann Aggressive Growth fund, which owns about 70,000 Terayon shares. "They're either going to be dramatically larger, or they're going to be part of someone else." |
