Hold onto your shares.....
Two 'Net Stocks Cisco Could Have Had
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individualinvestor.com
Alexander Yakirevich (5/8/00)
Networking giant Cisco Systems (NASDAQ: CSCO - Quotes, News, Boards) took
yet
another step in broadening its already diversified portfolio of communications
technologies when it announced last Friday that it would acquire Acton, Mass.-based
ArrowPoint Communications (NASDAQ: ARPT - Quotes, News, Boards) for $5.7
billion.
It's fair to ask what could have persuaded Cisco, arguably the savviest acquirer of
young
tech firms around, to pay a price that values ArrowPoint at several times more than the
value set at its initial public offering a month ago.
For investors, a better question is: What does this deal do for the emerging segment of
Internet traffic management systems. ArrowPoint, with a market share of 16.1%, is the
third largest competitor in the market, and its acquisition by Cisco offers a good
opportunity to look at two larger rivals, Alteon Websystems (NASDAQ: ATON -
Quotes,
News, Boards), which has roughly 35.7% of the market and F5 Networks
(NASDAQ:
FFIV - Quotes, News, Boards), which has approximately 30%, according to
Robertson
Stephens.
Alteon went public in September 1999, and it supplies switches, WebICs (application
specific integrated circuits used to expand switch capacity) and Web traffic
management
software. The company's customers include such blue chip technology companies as
IBM (NYSE: IBM - Quotes, News, Boards), Concentric Network, (NASDAQ:
CNCX -
Quotes, News, Boards), and Hewlett Packard (NYSE: HWP - Quotes, News,
Boards) .
The principal function of the systems sold by ArrowPoint, Alteon and F5 is to monitor
servers and so-called server farms, or collections of servers, and identify weak links
vulnerable to failures and pinpoint the servers with the best response time. As requests
come in from network routers, a switch sends traffic to a server that is able to process
the signal in the most expedient manner.
Robertson Stephens says the Internet traffic management market is expected to reach
approximately $1 billion within three years, although judging by the size of the
ArrowPoint
transaction, this forecast could be too conservative.
Judging from Alteon's latest quarter, the demand for the technology is clearly growing.
The March 31 quarter was the third of the company's 2000 fiscal year, and revenue
grew
65% sequentially over the December quarter to $28.2 million. The company also
added
350 new customers during the quarter.
The strong revenue growth and a 170 basis-point sequential improvement in the gross
margin helped cut the operating losses to $3.6 million in the third quarter from the $5.1
million posted in the December quarter.
Shares of Alteon dropped 6%, to $67, following Cisco's announcement, as investors
doubted sustainability of Alteon's market leadership. However, we think that the sell
off
may be overdone.
"Cisco's entry into the Web traffic management space validates the market," says Mark
Edelen of Thomas Weisel Partners. He also thinks that the opportunity will be large
enough to accommodate several vendors.
Ara Mizrakjian, an analyst with Robertson Stephens, notes that Cisco will initially
distribute ArrowPoint's products. However, it remains unclear when the company will
be
able to fully integrate ArrowPoint's technology to offer a bundled solution. As a result,
Mizrakjian sees no "near-term market share erosion" for Alteon.
At 41 times trailing-twelve-month sales of $66 million, shares of Alteon look like a
bargain
compared with the multiple of 270 times Cisco offered for ArrowPoint.
One thing that F5 Networks shares with Alteon is that it is also well positioned within
the
Web traffic management sector. That's underscored by the company's client list, which
includes MCI Worldcom (NASDAQ: WCOM - Quotes, News, Boards), Exodus
Communications (NASDAQ: EXDS - Quotes, News, Boards), and PSINet
(NASDAQ:
PSIX - Quotes, News, Boards) . Besides Web traffic management, F5 also sells Web
content synchronization technology, which allows enterprises with multiple locations to
synchronize Internet content across the network.
F5 shares another trait with Alteon, in that demand for its products is also growing
rapidly. In the March quarter, the top line expanded 527%, to $23.6 million,
compared
with last year and 23% sequentially.
Thanks to the stringent overhead cost control, the company posted operating income
of
$3.3 million in the quarter compared with the loss of $3 million registered in the same
quarter last year. In the year ago quarter, F5 lost $0.45 per share.
The company generated net income of $0.18 per share in both the December and
March
quarters.
Shares of F5 also declined in the aftermath of the ArrowPoint acquisition, for the same
reason that Alteon sold off. The stock fell 14%, to around $34. At 11 times trailing 12
month sales, we believe that the stock is attractively valued relative to ArrowPoint.
In the first hour of trading on Monday morning, Cisco, ArrowPoint, Alteon and F5
were all
down, but the session began with negative impact of a cover story Barron's printed
over
the weekend that questioned Cisco's ability to maintain its growth and high market
capitalization.
Alteon lost $2.25 to $64.75, while F5 fell $0.50 to $33.44. Cisco was off $3.25 to
$64.50,
and ArrowPoint was down $7.19 to $133.
Bottom Line:
Cisco's offer to acquire ArrowPoint certainly raised the profile of the Internet
traffic management market, and it set a high price for technological know-how in
the sector. Given their strong market shares and current operating momentum,
Alteon and F5 should not be ignored for long. |
