Article from IIE
Bid & Ask: Is Avanex a 'Buy' at $94?
individualinvestor.com
By Tom Byrne (10/31/00)
(Talk to Tom in his 'Tom's Bid & Ask' message board.)
Sometimes doing well just isn't enough.
Avanex (NASDAQ: AVNX - Quotes, News, Boards), which is in the hot
field of photonics, easily beat earnings estimates last quarter. The
company earned $0.03 per share versus expectations of breakeven
results.
Now, corporate behavior of that nature typically helps spur me toward
recommending a stock.
However, as they say down in Texas, where Avanex has a huge plant, you
would have to plumb loco to buy that kind of foolishness.
See, Avanex is trading at $94.05, or a lofty 672 times expected earnings
for 2001 of $0.14 per share.
Why so expensive?
Avanex is getting the Texas-sized valuation because it is the process of
making fiber optic cables more powerful.
Revenue for the first fiscal quarter (ended September) was $34.8 million,
up 8-fold over last year's revenue of $4.4 million, and 80% higher than the
prior quarter. Pro forma net income for the quarter was $2.3 million, or
$0.03 per share, excluding non-cash charges for amortization and R&D
associated with the company's acquisition of Holographix, versus a pro
forma net loss last year of $1.4 million, or $0.22 per share.
As an analyst, I prefer to keep amortization and R&D as operating costs,
and not to exclude them from my due diligence process. Including these
costs, Avanex lost $25.3 million, or $0.46 per share in the first quarter,
compared to a net loss of $22.4 million last year, so the loss widened
slightly year-over-year.
Avanex has just posted its first quarter of profitability on a pro forma basis,
yet investors had bid the stock up to a mind-numbing $273.50 earlier this
year. Even at $94, the company is sporting a market cap of $6.1 billion,
which is about 85 times trailing 12-month sales. Why all the excitement?
PHOTONICS
Avanex makes photonic processors, which help communications service
providers and optical systems makers achieve greater levels of
performance, in tandem with miniaturization. This is big news. Photonics
has the ability to make fiber optic cables, already the most powerful
bandwidth mechanism, even more powerful. It is hard to find anyone that
does not think this is a huge growth industry -- including me.
Plus, I am not saying Avanex is a bad company or it makes inferior
products. On the contrary, Avanex provides cost-effective,
high-performance photonic processing solutions that have been well
accepted by customers like WorldCom, Nortel, Lucent, Fujitsu, Hitachi,
Sycamore Networks, and Cisco Systems.
Communications network carriers like Lucent and Nortel are deploying
fiber optic transmission systems at a rapid rate, despite their recent woes.
All fiber optic companies want to improve their networks' ability to transmit
and manage the high volume of voice and data traffic generated by the
growth of the Internet, and do it with greater speed. Avanex is one company
serving that need for speed.
Fundamentally, photonic processing technologies increase the speed and
capacity of fiber optic networks. More specifically, they directly increase
the number of data-carrying wavelengths of light that can travel on optical
networks, and they extend the distance an optical signal can travel without
electrical regeneration. This is an important concept. Photonics allows
signals to travel at a faster rate for a longer distance.
Without photonics, signals need to be boosted at certain intervals to keep
them going. Thus photonics makes obsolete the need for these "booster"
devices, and makes deploying a fiber optic network cheaper to do.
Avanex currently provides two photonic processing solutions, which are
great products: the PowerFilter Wavelength Separators and PowerMux
Wavelength Channel Processors. The PowerFilter, Avanex's initial product,
has been shipping since October 1999 and has provided the bulk of
revenue to date. Shipments of the PowerMux, which incorporates
PowerFilter and adds functionality, began in March 2000. Avanex
anticipates that the PowerMux will replace the PowerFilter in most
applications, which is good and bad. Avanex will probably get more sales
of PowerMux, but it will lose sales of PowerFilter.
RISKS
The risks are not about the company, which has great products, strong
sales growth and is turning the corner into profitability (albeit on a pro
forma basis). They're about the huge risks associated with buying the stock
at $94.
Avanex is growing at a prolific rate. The company increased its workforce
to almost 1,100 employees from roughly 700 in the prior quarter. It closed
the acquisition of Holographix, and is tripling the size of its Richardson,
Texas plant. But with that growth comes a lot of headaches: training new
employees, retaining old employees, assimilating an acquisition and laying
off redundant employees, recruitment costs and building costs to name just
a few.
Those risks can be overcome. But high valuations are hard to fight and
even harder to sustain. Avanex would have to double earnings every year
for the next five years, just to be trading at 30 times earnings that are five
years away. Or put another way, it will take Avanex 686 years, making
$0.14 per share per year, to give investors back its current stock price.
The Street is riddled with carcasses of companies that sported high
valuations for years. But once growth slowed to moderate, from hyper,
those valuations come crashing down. See Microsoft, Cisco, Lucent, Nortel
and Yahoo, which all had triple-digit P/E valuations at one time. Not any
more.
Bottom Line:
Avanex is still in its hyper growth phase, and the future for
photonics is very bright. But wait for the valuations to come back to
earth before jumping in. |
