Silicon Investor (SI) -- The First Internet Community

STOCKTALK

We've detected that you're using an ad content blocking browser plug-in or feature. Ads provide a critical source of revenue to the continued operation of Silicon Investor. We ask that you disable ad blocking while on Silicon Investor in the best interests of our community. If you are not using an ad blocker but are still receiving this message, make sure your browser's tracking protection is set to the 'standard' level.

Technology Stocks : Extreme Networks, Inc. (EXTR) -- Ignore unavailable to you. Want to Upgrade?

To: Oak Tree who wrote (578)	5/9/2001 2:06:11 PM
From: riposte	Read Replies (1) \| Respond to of 770

Cisco's Upgrade Is Good -- for Extreme By Don Luskin Special to TheStreet.com Originally posted at 12:28 PM ET 5/8/01 on RealMoney.com My colleague Dave Nadig and I have received a tsunami of emails asking us to explain the pairs trade we put on Tuesday: Short Cisco Systems (CSCO:Nasdaq - news) and long Extreme Networks (EXTR:Nasdaq - news). Dave mentioned the trade earlier on RealMoney.com's Trading Track. And I mentioned the position, too, by way of disclosure in my earlier column on Cisco. The idea is to capitalize on a subtlety in Tuesday morning's upgrade of Cisco by Morgan Stanley's superstar networking analyst Christopher Stix. First, we're concerned that Stix's upgrade is a form of capitulation -- that he's too late, and has missed the majority of the move in Cisco. Second, we note that Cisco's growing business strengths cited by Stix in his upgrade may actually indicate even better prospects for Extreme Networks than for Cisco. Stix's upgrade of Cisco was based on Morgan's recent chief investment officer survey that points to stabilization in the enterprise market, particularly the Layer 3 switch market. After further channel checks, Stix believes that the corporate spending slowdown is winding up, and that we will see a pickup in enterprise demand in the next six months. Some 39% of the CIOs surveyed today indicated that they expected 81% to 100% of their switches to be Layer 3 capable, up from 22% of CIOs in the last survey. According to MetaMarkets.com networking analyst Chris Thiessen, "Layer 3 switching is Extreme Networks' strong suit. While it doesn't have a stranglehold on the market -- it is the No. 2 player behind Cisco -- its business is highly leveraged to Layer 3 switching. If there is a pickup in that market, Extreme will benefit a lot more than Cisco." Assuming you buy the Thiessen thesis, that leaves the question of how to engineer the trade. How many shares of Extreme do you buy, and against how many short shares of Cisco? The idea is to create a market-neutral position, one that will capture the perceived value gap between Cisco and Extreme whether the overall market, or the networking sector, is up or down. If you buy and short the same number of shares, you won't have a position that is neutral to overall market or sector risk. That's because Extreme (at $33.99 as I write this) is much higher-priced than Cisco (at $20.14 at the same moment). Buying the same number of shares that you short means you'll have almost twice as many dollars long the market as you would have short. That means if the overall market moves up, the position will be helped -- but if it moves down, it will be hurt. You can eliminate this problem if you simply dollar-weight the positions. That means you'd buy about 20 shares of Extreme for every 34 shares of Cisco that you short. Now you've got the same number of dollars both long and short in the market. That's a big improvement in risk control compared with just trading the same number of shares of each stock. But you can take it one step further. Remember that what you want to hedge here isn't actually the dollar value invested on both sides of the trade now -- rather, you want to hedge the future changes in the dollar value of the trade. That means you'll want to take into account the fact that Extreme -- a much smaller and younger company -- has a much more volatile price than the larger and better-established Cisco. So a given number of dollars at risk in Extreme is effectively larger than the same number of dollars at risk in Cisco. Our solution is to weight the trade by the two stocks' respective volatilities. Volatility is a statistical measure of the distribution of a stock's price changes. The higher the volatility, the higher the risk. According to Bridge Information's BridgeStation, Extreme's volatility is rated at 165.8, while Cisco's is 100.8. Both numbers are extraordinarily high by any normal historical standard -- but what counts for this trade is just the difference between them: a ratio of 1:65 to 1. The difference between the volatilities means that you'd want to buy less Extreme (the more volatile stock) and short more Cisco (the less volatile stock). With simple dollar weighting, you'd have shorted 34 shares of Cisco -- so now multiply that by 1.65 to scale it up to match the volatility of Extreme. That will give you 56 shares of Cisco short, to 20 shares of Extreme long. To round it into convenient trading lots, you'd short 5,000 shares of Cisco for every 1,800 shares of Extreme. I'm sure I needn't warn you of the risks in such a trade. While on the one hand you are -- at least theoretically -- neutralized against market and sector risk, the reality is that you have separate positions that may end up not hedging each other at all. You might say you now have two ways to be wrong. But then again, if you thought you were going to be wrong, you wouldn't make the trade. We debated whether to put this trade on ahead of Cisco's earnings Tuesday night, and decided to at least establish a pilot position. Whatever Cisco says, it will rock the whole sector -- and probably the whole market. We're betting that the more information investors have, the more they'll see the strength developing right in Extreme Networks' sweet spot. thestreet.com

To: Oak Tree who wrote (578)	5/11/2001 7:01:11 PM
From: Herschel Rubin	Read Replies (1) \| Respond to of 770

A BUBBLE STOCK - IS EXTREME NETWORKS HITTING EXTREME PRICES? __________________________________________ May 2, 2001 3:29 pm EST New York (Jackson & Steinburger) - At $38.00/share today, Extreme Networks is clearly a bubble stock, sporting a Price Earnings Ratio (PE) of 475 time this year's earnings consensus and 237 times next year's earnings. With analyst consensus estimates at $0.08 for the current fiscal year ending June 2001 and $0.16 for the fiscal year ending June 2002, we see these PE's as unsustainable, even in a marginally recovering economy. Here's the numbers: $38.00/0.08 = 475 PE for the fiscal year ending June 2001 $38.00/0.16 = 237 PE for next fiscal year To justify high PE stocks, the common rationale is to evaluate a stock's PEG ratio (PE divided by growth rate). Generally a PEG ratio roughly equal to its growth rate is considered rational. The question buyers should ask themselves is: "Does Extreme Networks have a 475% growth rate to support a PE of 475?" Clearly not. Again, using $0.08 as the consensus EPS for this fiscal year ending June 01 and $0.16 for the next year, it appears that Extreme Networks is projected to have a 100% growth rate. With a 100% growth rate, one would then conclude that if Extreme Network's PE should also be roughly 100 times current year earnings of $0.08, the stock should be trading at around $8 per share. Failing that test, our optimists might plead us to base fair valuation on next year's $0.16 EPS estimate to arrive at a fair value of $16/share, less than half of current lofty trading levels. During the April 18th earnings conference call in which Extreme Networks announced a 7 cent per share loss (not to mention a -$0.64 non-proforma operating loss) for the January-March 2001 quarter, Extreme Networks management was asked if some projections of a loss of 10 cents for calendar year 2001 was in the cards. Management at first said they would earn more than that but offered no specifics. When pressed further, they indicated they'd be profitable in calendar year 2001. How profitable? We can only wait and see. And with current share prices for Extreme Networks reaching speculative levels, waiting on the sidelines is all we would be doing. With 7 million shares short, much of Extreme Network's advance may be attributed to short shares being forced to cover, otherwise known as a "short squeeze." Although we rarely short stocks, this is one we would feel comfortable shorting until valuations return to rational levels. Short squeezes are actually excellent opportunities to initiate a short because such rallies rapidly deflate once the buying associated with short covering margin calls plays itself out and the stock collapses. A short position in Extreme Networks (or equivalent "bubble stock") can serve as an effective hedge against a pullback in the Nasdaq which has made substantial gains in the past 4 weeks and is likely to sell off on or before the May 15th Federal Open Market Committee meeting. During Nasdaq pullbacks, high PE stocks usually take the brunt of the selling and EXTR would be no exception, having vaulted 216% from its April 4th low of $12.00 per share! In the case of Extreme Networks, if this bubble reaches any higher, it'll escape the Earth's atmosphere. Copyright (C) 2001 Jackson & Steinburger _______________________________________