[Needham Report. Found on the Yahoo! board for DMIC]
(DMIC is their top pick this month... see further below.)
part 1
NC: WIRELESS COMMUNICATIONS, THE FALLOUT FROM NOKIA`S STUMBLE. Page 1 of 2
10:49am EDT 8-Aug-00 Needham & Co. (Richard Valera 212-705-0373) ADAP ANEN CLT
Needham & Company Richard Valera
August 8, 2000 Rvalera@needhamco.com
(212) 371-8300
Wireless Communications
The Fallout From Nokia's Stumble
On July 27, Nokia reported surprising 2Q00 results, as it met EPS estimates,
came up shy of the high-end estimates for handset revenue growth, and revised
downward its EPS guidance for the 3Q00. For Nokia (the 800-pound gorilla of the
handset industry, which has consistently treated the investment community to
upside surprises, even as its competition struggled) this proved to be an
unforgivable offense: Nokia's share price fell 26% that day and sent virtually
the entire tech market, particularly companies with any wireless exposure,
reeling. Of course, it was more than just the Nokia call that investors were
responding to. There had been a growing uneasiness in the markets about signs of
possible slowing of handset growth. There is an entire food chain of
electronics component suppliers-including providers of gallium arsenide (GaAs)
amplifiers, DSPs, flash memory, capacitors and displays-that is dependent on the
continued robust growth of the handset market. Thus, this indication that the
acknowledged market leader was showing signs of weakness was enough to cause
many investors in wireless-related stocks to sell first and ask questions later.
Nokia's 2Q00 results appeared impressive, as it reported year-over-year revenue
growth in its handset unit of 67% and staggering 25.0% operating margins in this
unit. (To put this in perspective, investors cheered when Motorola reported an
improvement to 4.0% handset operating margins in its most recent quarter, and
Ericsson reported a negative 6% operating margin in its handset division due to
a fire at one of its suppliers.) However, Nokia missed the high-end handset
revenue Street estimates (aggressive as they may have been) and therefore failed
to produce upside to the consensus EPS estimates for the quarter. Some
investors interpreted this lack of upside as a sign of a weakness in the overall
handset market. Nokia's guidance for sequentially down EPS in the 3Q00 was
cause for even more consternation. Even though Nokia attributed the lower EPS
expectations to what appeared to be a company specific execution issue (slippage
of several new products introductions, which would tend to depress margins),
this sign of weakness by the company known for its flawless execution was also
interpreted as a negative sign for the entire handset market.
The Nokia call built on growing concerns in the investment community that the
torrid pace of handset growth might be abating. Indeed, the stocks of many of
the component suppliers into the handset market had been under substantial
pressure for the past month or so even as most of them were handily beating
estimates and upwardly revising forward guidance. Most investors' concern seemed
to focus on one number: the estimated number of handsets to be produced in
2000. Historically, at least in the last couple of years, this has been a number
that was subject to numerous upward revisions throughout the year. In 1999, for
example, when the year started, market research firm Dataquest estimated the
number of handsets produced would be 220 million; however, the total for the
year exceed 280 million. In 2000, most industry sources pegged handset unit
shipments somewhere north of 400 million units, with the high end of the range
approaching 500 million; however, as the year has progressed, rather than this
high-end range being upwardly revised (as it had in the past), it seems that the
consensus range has drifted down to 420-425 milli
Although it appeared that the market had absorbed the news of handset unit
shipments being "only" around the 425 million level, on August 3 a second shoe
was dropped on wireless related stocks. The day after Motorola's very bullish
annual analysts' meeting (in which it reaffirmed its previous earnings guidance
and worldwide handset shipment expectations of 425-450 million units), news
leaked out that Motorola had guided its suppliers to expect the company to
produce 80-85 million units in 2000, down from its previous 100 million units
estimate. For its part, Motorola maintains that its guidance has always been
that it would ship 80-85 million handsets this year, even though it admitted to
having set up its supply chain at the beginning of the year to be able to
produce 100 million handsets. Based on public comments from some of MOT's
suppliers, its appears that MOT has been guiding supplier expectations toward
the 80-85 million unit mark for at least a couple of months now as a result of
the company's decision to streamline the number of products in its handset
portfolio to focus on long-term profitability rather than short-term unit
growth.
Our View. We believe that, on the margin, handset unit growth assumptions for
the year probably have come down from the 450 million-plus level to the 420-425
million range. We note that this would still represent 50% year-over-year unit
growth in handsets, a growth rate unmatched by any other electronics product
with similar size unit base. We believe the divergence from high-end
expectations is due to expectations that were unrealistic and events such as the
end of Korean handset subsidies, which is expected to roughly cut in half the
number of handsets shipped in Korea this year from 15 million to 8 million.
Regarding Motorola's alleged change in guidance, we believe that the company's
suppliers have been well aware of MOT's change and had already factored it into
their guidance to the Street. Secondarily, we believe that suppliers that are
providing components for MOT's new high-margin handset platforms are actually
likely to be seeing accelerating demand as MOT's shifts away from its older
lower-margin products.
Bottom line, we believe Nokia's earnings warning will have minimal implications
for wireless infrastructure providers. Nokia's infrastructure business showed no
signs of weakness in 2Q00, nor did Ericsson's or Motorola's. While one could
reach the conclusion that handsets are a leading indicator for infrastructure
(since fewer handsets would imply fewer subscribers and eventually less
infrastructure), we believe this a tenuous relationship at best. First, we note
that by Nokia's estimates approximately half of the handsets sold this year will
be for replacement/upgrade buyers. Since no change in the number of wireless
subscribers is implied by replacement sales, they are unlikely to have a
meaningful impact on infrastructure demand. Also, many of the companies we cover
provide fixed broadband wireless access equipment or subsystems, which are
seeing exceptionally strong demand that is being driven by a different set of
dynamics than the cellular/PCS infrastructure market-namely solving the "last
mile" bandwidth bottleneck. Therefore, despite the pounding taken by the
wireless infrastructure stocks in our coverage universe last month, we continue
to believe that infrastructure, particularly broadband wireless access
equipment, remains a very attractive area to be exposed to.
10:48am EDT 8-Aug-00 Needham & Co. (Richard Valera 212-705-0373) ADAP ANEN CLT
Review of Last Month's Picks
Last month was a forgettable one with regard to the performance of our covered
stocks. While our cautionary comments about potential volatility in the handset
sector proved to be warranted, our recommendation that investors focus on
broadband wireless infrastructure as a relative safe haven to companies with
substantial exposure to handsets clearly missed the mark. As seen in Figure 1,
the stocks in our coverage universe were down an average of 19% in July, mostly
victims of the indiscriminate selling that hit wireless stocks following the
Nokia earnings call. The only company in our coverage group with significant
exposure to handsets is Celeritek, which reported an excellent quarter (as we
expected) and was down 14% for the month-less than the average of our more
infrastructure-focused stocks.
Our top pick last month, Digital Microwave, was clearly a miss. Despite
tremendous business momentum entering the last two weeks of the quarter and a
strong track record of turning orders into revenue, DMIC came up well short of
our and the Street's revenue estimates for the quarter due to issues with two
suppliers at the end of the quarter. The company's impressive bookings, strong
bottom line performance (it beat the consensus EPS estimate by $0.02 despite the
revenue miss) and strong Altium bookings and shipments were not enough to
compensate for the revenue miss, and the stock ended up the month down 27%
(terrible on an absolute basis and bad on a relative basis). Our other
recommended pick for the month was P-COM, which finished the month up 7%-making
it the best performing stock in our group for the month. P-COM shares
appreciated meaningfully intra-month to the $8.50 level, only to sink back to
its earlier levels due to a disappointing earnings report, as the company
continues to struggle on the execution front.
This Month's Picks: Digital Microwave (DMIC, $24.75, Buy) and Celeritek (CLTK,
$31.44, Buy)
Digital Microwave is our top pick this month. Despite its supplier-related top
line miss last quarter, our conviction in the strength of DMIC's Altium products
cycle and the quality of its management team remain unshaken. We believe the
company has a handle on the supplier issues that caused the shortfall in
shipments of its mid-range (XP4 and Spectrum II) products, and we believe it is
poised to show strong sequential revenue and earnings growth in the September
quarter.
We believe there were several other substantially positive developments related
on the company's earnings call that were obscured by focus on the revenue miss.
DMIC's key Altium product line showed excellent results with $23.7 million of
revenue (30% sequential growth) and $40.7 million of bookings for a 1.7:1
book-to-bill. Altium is now shipping at an almost $100 million annualized run
rate in its sixth quarter of production shipments and is the clear leader in
what we believe is one of the hottest segments of the broadband wireless
infrastructure market. The strong demand for DMIC's products and the health of
the industry were reflected by exceptional bookings of $126 million in F1Q01,
resulting in a 1.45:1 book-to-bill. Finally, DMIC's F1Q01 gross margin of 35.2%
was 270 basis points above our estimate, despite a significant revenue miss,
which we believe demonstrates solid operational skills as well as strong demand
for DMIC's products.
Our other pick this month is Celeritek, which has recently been hammered
(closing at $31.44 today) due to concerns about its exposure to Motorola's
handset business. We believe Celeritek remains in an excellent position with MOT
as one of the preferred power amplifier (PA) suppliers for MOT's next
generation handset platforms. We believe CLTK is seeing robust demand for the
PHEMT-based designs it is currently shipping to MOT, and that the company is
poised to receive a major order from MOT for its next generation InGaP HBT,
module-based PA products within the current quarter.
Demonstrating its current business momentum, Celeritek recently reported F1Q01
results of $19.7 million in revenue and $0.07 in EPS, substantially exceeding
our $16.5 million and $0.04 estimates and consensus $0.05. Celeritek also
continued to demonstrate strong demand for its products with a 2:1 book-to-bill
for the quarter, bringing backlog to a record $84 million (split roughly $42
million Subsystem, $28 million GaAs and $12 million Defense). For the quarter,
CLTK's GaAs business generated $8.7 million of revenue, handily exceeding our
$7.0 million estimate, as it benefited from strong demand for its CDMA PAs
shipping into Motorola's new low-end CDMA phones. With strong demand in both its
Wireless Subsystem and GaAs businesses, we believe the key to the Celeritek
story continues to be capacity expansion. On this front, we believe the company
made good progress in F1Q01 with the receipt of additional test equipment
substantially augmenting its GaAs capacity and two additional steppers (for the
fab) due to be installed in the next quarter. |
