Cable Will Dominate ?
Harmonic Progression for a Broadband Company
By David H.M. Baker, Columnist
Earnings warnings have pounded Harmonic into the ground. But cable could tow it out.
The current ``take no prisoners'' momentum market offers some great companies at very attractive discounts to their potential long-term earnings.
My current favorites include infoUSA (Nasdaq:IUSA - news), Network Plus (Nasdaq:NPLS - news) and my newest addition -- a bandwidth play -- Harmonic Lightwaves (Nasdaq:HLIT - news).
Harmonic designs, manufactures and markets digital- and fiber-optic systems for video, voice and data over cable, telecom, satellite and wireless networks. The company's shares have fallen out of the sky the past several months on disappointing earnings forecasts, which took the stock down 82% from a high of 157 1/2 on March 6.
My premise -- which to many is quite controversial -- is that the cable systems will be the de facto delivery platform for broadband services. The cable plant is the only scalable, secure and economically feasible delivery network for the oncoming explosion in broadband demand. Other technologies currently in play will prove to be vastly inferior, especially any that include any of the copper based solutions, like digital subscriber lines (DSL).
Harmonic Convergence
Wireless may have a hand in this game for narrowband applications on mobile devices. However, cable will prove to be the overwhelming broadband platform for the home.
Satellite will be a large player, but in a way very different than many investors realize. These companies will never have the bandwidth to deliver interactive two-way broadband services to the end-user and their role will ultimately be to deliver content to the edges of the network, like a cable head end, which in turn will provide the broadband access to the customer.
I mention these points specifically to lay the groundwork for my thesis for Harmonic. Today, Harmonic is providing solutions, technology and products primarily to cable and satellite companies who ultimately will be rule the broadband kingdom.
The investment community is totally enamored with infrastructure plays. However, as more bandwidth approaches the edges of the network, the same investor intensity will focus on access providers like Harmonic.
The irony here is that Harmonic is playing in the same arena as many of the leading fiber-optic component players like JDS Uniphase (Nasdaq:JDSU - news), Nortel (NYSE:NT - news) SDL (Nasdaq:SDLI - news) and Ciena (Nasdaq:CIEN - news), yet it trades at a fraction of their value.
The difference is that Harmonic is focused on the access network, or the part of the network closer to the customer. The aforementioned leaders are delivering components to support the growth of the core backbone to the global network infrastructure.
Living in Close Quarters
The stock has taken a beating the past three months, falling wider than 80% on the heels of a disappointing earnings announcement. Unfortunately, Harmonic was one of the favorites of the momentum crowd and when a momentum stock stumbles, the short-term outcome isn't pretty.
The down stroke on the shares was overdone -- however, these shares had no business trading over $150, either. So that cuts both ways, and now it is up to the company to deliver.
There is no question that risk still exists, as the company must digest the Divicom acquisition and expand its customer base beyond a few core clients. The key point is that none of these issues that caused the short-term earnings disappointment are related to the core long-term opportunity I foresee for the company.
However, having said this, it may take a few quarters for the company to get back on track, which may put a short-term cap on the valuation.
There appears to be some issues with the Divicom unit, primarily related to some organizational issues and a slowdown in satellite-operator spending. Again, I do not view these as terminal, but the progress should be tracked closely for any indications of deeper problems.
Playing to Strengths
The company appears to be making progress broadening its client base away from AT&T (NYSE:T - news). RCN (NYSE:RCN - news) was a 10% customer in the most recent quarter and Charter Communications (Nasdaq:CHTR - news) is now a large customer.
A number of analysts have slashed their estimates for the company to the point where the consensus earnings-per-share (EPS) forecast is around 70 cents to 79 cents for 2000 and 2001 respectively. This represents a cut of approximately 40% for 2001, which is fairly conservative, especially if Harmonic quickly and successfully folds Divicom's operations into its own.
This is never an easy task, but given that the company recently announced the completion of the structural reorganization, it should be well on its way on this count.
The other strength I see with Harmonic is its leadership technology position. With the Divicom acquisition, the company secured one of the leading broadband compression solutions, which fits very nicely into its own technology-driven products. This elevated Harmonic to an integrated broadband solutions provider, whose value will become increasingly evident in lockstep with consumer broadband demand.
The Focus of Optical Players
If for some reason Harmonic fails to execute on its current opportunities, it will become a very desirable acquisition target by any of the major optical players, including Nortel, JDS Uniphase, or Cisco (Nasdaq:CSCO - news). This provides the investor with some degree of protection and should limit downside risk, especially from current levels.
My clients do not yet have a position in the stock and I intend to establish an initial small position and add to it as the company demonstrates progress on executing its model. This would include meeting revenue targets, customer growth and operational issues with the consolidation of recent acquisitions.
The risk from my vantage point is that the stock trades sideways through the rest of the year before making its real upward move from the dramatic expected acceleration in demand for broadband solutions.
David H.M. Baker CFA is an analyst for worldlyinvestor.com and president of Rivendell Capital Management, a private-client money management firm, and a partner in Vision Investors LP, a Boston-based hedge fund. His column covers stocks that he feels are undervalued relative to their peers. He does not hold a position in any of the companies mentioned. Positions can change at any time. |
