Short Stories: Ascend Shorts Are Hurting -- and Quiet
By Kevin Petrie
Staff Reporter
6/11/98 5:13 PM ET
Call it the case of the missing short-sellers.
In the last few months, short interest in Ascend
(ASND:Nasdaq) has steadily climbed. The company is now
among the most heavily shorted big stocks, with almost 9%
of its shares sold short, according to Short ALERT, a
service of Rockbridge Research. (A primer for this column
explained that short-sellers sell stock they don't own, hoping
to repurchase it later after the price of the stock has fallen.)
But many of Wall Street's best-known short-sellers tell TSC
that they aren't shorting Ascend, a fast-growing maker of the
machinery that runs the Internet. In fact, Ascend shorts have
been on the run as the stock has doubled since December.
But bulls on the company are easy to find, despite (or
maybe because of) Ascend's recent runup.
"Everything we're hearing says the fundamentals are strong,"
says Doug MacKay, assistant portfolio manager at Oak
Associates. Oak continues to add to its huge stake in
Ascend, which totals 3.7% of shares outstanding.
The reasons to invest in Ascend are numerous, analysts and
money managers say. Smaller data networking companies
have retreated somewhat as Ascend and Cisco
(CSCO:Nasdaq) compete for the more lucrative business
and position themselves to raid the telephone-equipment
sector. That makes Ascend a compelling takeover target for
giant phone-gear companies like Lucent (LU:NYSE) or
Northern Telecom (NT:NYSE) as well as a strong player in
its own right. And with Internet traffic soaring, Ascend's
revenues are expected to grow roughly 35% next year, to
almost $2 billion.
Ascend is in good shape partly because one year ago the
company purchased Cascade, which furnishes phone
carriers with huge switches that direct rush hour on the
Internet freeway. In addition, one source close to the
company says Ascend is seeing a rebound in its core
business of tying Internet service providers such as UUNet,
part of WorldCom (WCOM:Nasdaq), to their customers with
giant modem banks referred to as "remote access"
products.
Ascend executives also seem to have changed their tune --
for the better. Last year, they talked up a new line of remote
access units, even as some units literally were catching fire,
according to reports, when customers tried to use them.
This year, they've toned down the hype and stepped up the
performance. In fact, Ascend is selling remote access
products at a nice clip.
Ascend stock got another short-term boost this week on
news that the company would join the S&P 500 Thursday,
replacing Digital Equipment. That means both closet and
confessed index fund managers will tuck Ascend into their
portfolios.
Possible Pitfalls
So what's left to complain about? The price.
"The reason the stock's shorted is that it's had a big run-up,"
says one erstwhile short who played Ascend's descent from
40 to 30 last year before covering. Ascend stock ended
Thursday up 3/8 at 48 7/16, a sharp rise from 24 1/2 at the
start of the year. It trades at 110 times trailing earnings and
41 times expected 1998 earnings, compared with 82 and 41
for the networking titan Cisco.
The money manager who missed Ascend's bounce this year
says he won't go long its pricey shares now. But he doesn't
spot leaks in the story either. "I think the shorts are wrong."
Still, Ascend has stumbled badly before. Despite its recent
gains, the stock trades well below its high of 78 3/4, set in
January 1997. What happened? For one thing, competitors
such as 3Com (COMS:Nasdaq) pared prices sharply. More
importantly, there were serious flaws in Ascend's ambitious
upgrade of its MAX TNT remote access products to handle
modem speeds of 56 kilobits per second. As profits
tumbled, Ascend stock fell as low as 23 5/8 in December.
CEO Mory Ejabat faced intense criticism for waxing bullish
at summertime conferences while such an important product
line was crumpling. But now, remote access sales have
rebounded, and bulls aren't holding a grudge.
The only risk to Ascend now is that a small pool of
increasingly large Internet service providers and phone
carriers purchase its products in a stop-and-go fashion,
according to fund manager Grant Cowley with the
U.K.-based firm Perpetual Investments. Still, Cowley is
standing pat with his Ascend stake after buying in the
mid-30s early this year. He says the stock might hit 55 this
year.
Thwarting Cisco
Of the networkers, only Ascend has held the Cisco
steamroller at bay. Cisco has steadily gobbled share in
most markets, such as routers and switches used to send
data through smaller corporate local-area networks. But in
the high-end switching business, it's Ascend that has built a
mountain of long-term orders from phone carriers groaning
under the weight of the Internet. Ascend gained the edge the
old-fashioned way -- it bought a company Cisco wanted.
In late 1993 Cisco paired with Cascade to develop products
jointly and market Cascade products to phone carriers and
ISPs. Cisco also took a small equity stake in Cascade, and
was rumored to be angling for an outright purchase. But
Cisco started divesting itself of that investment when instead
it acquired StrataCom, a rival of Cascade, for stock worth
roughly $4 billion in April 1996.
Ascend "got the No. 1 company in their business. Cisco
ended up with No. 2," says Bob Bender of Robert Bender
& Associates. "Cisco's still trying to get into Ascend's
business, and they're having a very difficult time doing it."
Bender's firm still is building its long-term investments in
both stocks.
The Lucent Play
Ascend's strength in switching is crucial to the
"convergence" of phone and computer networks, making the
company a tasty potential takeover candidate.
Phone carriers such as Sprint (FON:NYSE) and Bell
Atlantic (BEL:NYSE) are touting plans to build a new kind
of network to transport phone calls and data messages
simultaneously. One part of these networks will use
so-called dense wavelength division multiplexing, or DWDM,
boxes that boost bandwidth -- the amount of information that
can cross a network -- by sending multiple light waves
through an optical fiber. Suppliers are hustling to meet the
carriers' demands: Tellabs (TLAB:Nasdaq) is buying Ciena
(CIEN:Nasdaq), the best builder of DWDM, to secure a spot
in this game.
Meanwhile, Ascend is the top builder of the switches that
will direct traffic over the network. The switches use
technologies called asynchronous transfer mode, or ATM,
and frame relay. And Ascend said earlier this week it is
working with carriers such as Williams (WMB:NYSE) to
sew its ATM switches directly onto DWDM boxes, in some
cases obviating the need for older products that companies
like Lucent build.
So Lucent, a mammoth phone supplier spun off from AT&T
(T:NYSE) in 1996, has to make some changes. Lucent is
trying desperately to cook up its own DWDM solution. And it
might go shopping for the other piece, a strong ATM/frame
relay product.
Acquiring Ascend might fit the bill. With a market cap of
$9.1 billion, Ascend is no small morsel. But by folding
Ascend into its operations, Lucent would fuse two powerful
technologies and prepare for the erosion of aged network
products.
Ascend's technological position makes it a palatable
acquisition candidate, according to analyst Pete Deininger
at Firstar Investments.
"I would not be short the stock right now," Deininger says,
although he didn't disclose his position or investment history
with the stock. Technimetrics doesn't list Firstar as a
shareholder of Ascend as of March 31.
"It's more a question of what point you get in," Deininger
says.
With all the optimism, it's no wonder the shorts aren't
talking. |
