Re: DSL- Orckit: Pros and Cons Article
Thread- For those that don't know, Orckit(sym:ORCT) is a pure play equipment company in the DSL access space. In a unusually balanced approached, comes this article from Israelinvestor. It presented both side of the ORCT debate. Obviously Merill Lynch called this one somewhat correctly because Orckit did end up warning after this article was published.
I did not listen to the warning CC, so I'm not sure how well ML predicted the details of the problems facing ORCT. I hope to have time to listen to a replay soon. -MikeM(From Florida)
PS Threaded to this post is the Q100 DSLAM rankings. ORCT is number 7 in the world with a 5% share.
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ORCT: A Glass Half Empty or a Glass Half Full?
7/6/00- Due to Orckit's warning we bring this article again
Mark Savolainen Smith-- Recently both Merrill Lynch (ML) and Kaufman Brothers (KB) have issued updates on Orckit Communications (ORCT). These reports couldn't be more different in tone. ML continued (since its May 24th U-turn) in dirge-mode, pointing out any and all of Orckit's potential weaknesses. KB on-the-other-hand was happy to dwell on the upside (with minor qualification).
The bottom line: ML has dropped its 12 month target from $110 to $36 (implied), and its near-term buy rating to hold. At the other extreme, KB showed no fear, reiterating a buy rating and a 12 month target of $160 (a mere 400+ % gain from Friday's close).
Just as the same glass can be described as either half empty or half full, analyzing essentially the same information, each company seems to view Orckit quite differently.
May and June
For Orckit, the months of May and June have been fermenting with both news and rumors. Whether the result will be wine or vinegar remains to be seen. The news has been good so far. Orckit acquired EDSL networks and seems poised to become a significant player in the emerging MTU (multi-tenant unit) xDSL market. Orckit also launched its next generation of ADSL equipment and began shipping its long awaited Keywave-based product.
Additionally, two major wins were announced: Telia in Sweden and Dreamline in South Korea. Topping off the news, this last Friday, Orckit announced that Orckit shareholders will soon receive their Tioga shares (shares in Orckit's semiconductor spin-off).
On the other hand, negative rumors swirling around Orckit have been cause for concern. Confidence in Orckit's future with its two major customers (Deutsche Telecom and GTE) has been shaken. Additionally, many suspect Orckit will soon issue a Q2 warning.
Deutsche Telecom (DT)
ML precipitated the last stage of ORCT's recent fall ($40s to $20s) in May, when it claimed that DT had "halted ordering Orckit's systems" due to poor performance of Orckit's ATM offering.
Although neither Orckit nor DT has commented publicly, it appears that ML at the very least overstated the situation. ML is now saying that "vs. expectations".. there likely will be a "drastic decline in orders this year." (20,000 lines vs previously expected 100,000 lines) rather than a complete halt.
Taking a very different perspective on DT, KB comments simply that "Shipments to Deutsche Telekom... are due to be cut over the next quarter"... due to a "request by Deutsche Telekom to delay the ramp up in DSLAM shipments until the new product is available."
KB even manages to find a silver lining to the DT cloud: ".. since this [current] product is not profitable anyway, .. [not selling more of it] would likely result in higher profitability [for Orckit]."
GTE
Although Orckit continues shipping increasing numbers of lines to GTE, its largest account, Orckit's position with GTE does not appear as solid or secure as it did only a few months ago.
ML points to two related factors which may work against Orckit two years hence. One is the selection by Bell Atlantic, GTE's merger partner, of Nortel, rather than Orckit/Fujitsu, as a second preferred ADSL supplier (after Alcatel). The other is the expected gradual shift by GTE to ATM-based systems, where Orckit's product line is perceived to be weak. ML says these two factors may significantly slow Orckit's GTE sales in 2002.
KB takes a more positive near-term view, noting simply that new Orckit product, utilizing the profitable Keywave chipset, is now shipping to GTE.
Valuation Analysis
Despite their differing opinions of Orckit's prospects, neither ML nor KB is changing its estimate of the number of lines to be shipped by Orckit this year.
Simply put, temporarily reduced shipments to DT are expected to be offset by the current aggressive ramp-up of Dreamline (Korea) and the Q4 Telia ramp-up. Meanwhile, GTE's purchasing is expected to be as forecast.
In light of this, how does ML justify the drop in its 12 month target from $110 to $36? First, curiously, ML changed its basis of valuation for Orckit's systems business from a price/sales comparison to peers, to a price/earnings model based on a "a food retailer P/E level", a notoriously low margin and slow growth business.
Secondly, ML halved its valuation of Tioga from $500 million to $250 million, with no explanation.
Of KB's $160 target for Orckit $15 is assigned to Tioga and $145 to Orckit's systems business.
An Earnings Warning for Q2?
Both ML and KB speak of potentially weak Q2 results due primarily to delays in shipments of the new Keywave product. Both see the potential for a further stock price decline because of this, but where ML urges caution, KB sees opportunity, noting that should there be a "panic sell-off in the stock..., we would view this as probably the last great buying opportunity in ORCT shares."
Rumors are that Orckit will not only warn of a Q2 earnings shortfall, but also announce writeoffs for outdated inventory and costs associated with the EDSL acquisition. To help offset the bad news, possibly another win could be announced, maybe a European CLEC.
If this volatile scenerio should come to pass, Orckit will be asked many hard questions. If Orckit's answers are not convincing, its glass may well be half empty and on the way to further long-term decline. ML's food retailer P/E's valuation, while far-fetched, may be accurate.
On the other hand, if Orckit can soon convincingly show that its years of sacrificing profitability for market share are finally paying dividends with gross margins on the upswing, much might soon be forgiven as investors, now watching from sidelines, pile in before Orckit's glass fills to KB's levels. |
