<A> SMARTMONEY ONLINE: The Other Broadband Internet Play
By Joshua Albertson
SmartMoney Interactive
NEW YORK (Dow Jones)--Coaxial cable is sexy. That's the buzz after AT&T (T) plunked down $48 billion to acquire cable king Tele-Communications (TCOMA) and its access to millions of American homes.
Cable modems? Well, to some investors, they're sexier than Baywatch. At Home (ATHM), the service provider that brings high-speed Internet access into homes through cable wires, shot up 30% on Wednesday and now trades at almost 457 times trailing sales. That was due in part to TCI's large stake in At Home, but it also reflects the perceived promise in cable-Internet hookups.
Some of the excitement is justified. But there is likely to be more than one path to high-speed Internet access. And in all the current hysteria over cable modems, another solution is being overlooked. We're talking about copper telephone lines. In fact, most experts are betting that good old-fashioned phone lines will be running side by side with cable as the world's telecommunications concerns place their bets on tomorrow's voice and data delivery system.
That's why we decided to focus today's screen on companies involved in digital subscriber line (DSL) technology. The two companies we liked best, PairGain (PAIR) and Orckit (ORCTF), are involved in the most promising type of DSL, which was why, far more than their financial condition, they made the cut.
DSL is an important technology and we think you need to understand it to make an intelligent evaluation of the prospects for the se companies. But if you'd rather skip to why we like PairGain and Orckit, click here. Or read on until you get there.
Essentially, DSL magnifies the bandwidth of a copper telephone wire, enabling the simultaneous transmission of voice, data and video at speeds far faster than traditional analog delivery. DSL technology - which focuses on the most congested part of the telephone network, the so-called last mile between the local exchange carrier's central office and the home - is saving cop per wire from obsolescence.
"What DSL does [for telephone companies] is it extends their investment in copper plants," says David Smith, vice president at Technology Futures.
That's crucial, because with the wide-scale deployment of high-speed fiber optic wires at least a decade away, copper is the only game in town for most local carriers.
DSL comes in many flavors - VDSL, SDSL, RADSL and HDSL - but the one with the most relevance to the consumer is asymmetric digital subscriber line or ADSL.
In this case, asymmetric means that end users of the technology can bring in information - over the Internet, say - at speeds greater than they can send it out. But that's fine for most consumers, and the push to provide ADSL modems en masse, which has previously been a lot more talk than action, is heating up. "I believe AT&T buying TCI actually accelerates the telco deployment of ADSL," says Steve Levy of Salomon Smith Barney.
The telcos could use a jump-start, because in the race to provide home s with high-speed access, cable has a pretty good lead. There will be about 425,000 cable modem subscribers by year's end compared with only tens of thousands of residential DSL modem subscribers, according to the Yankee Group, a telecommunications research outfit. But both groups are expected to grow posthaste. In 2002, more than 3.35 million homes will get their Internet access through cable and 2.65 million through ADSL and DSL-Lite (an ADSL cousin), says the Yankee Group's Craig Driscoll.
ADSL's growth will stem, in part, from a couple of advantages that it holds over cable. First, cable modems have what Smith calls a "summing problem." They're fast as a hungry cheetah when only one person on the block has one, but once all the neighbors sign on, the network slows. ADSL modems don't face that problem. Second, and perhaps more importantly, telephone networks are already set up to handle two-way traffic. According to Driscoll, only one-quarter of cable plants are equipped for the give-and-take of voice and data transmission. Upgrading the rest of those plants will take time.
Of course, not everything is rosy for ADSL. Cable companies and cable Internet service providers like At Home and Roadrunner, a joint venture of Time Warner (TWX) and MediaOne (UMG), have invaded the public consciousness far more effectively than any providers of DSL technology. And ADSL has failed to live up to its billing to date, reaching far fewer consumers than had been expected in earlier estimates. That's partly due to the fact that many telephone central offices still lack technological capacity to offer ADSL modems to consumers. But with most of the cable concerns experiencing significant runups in recent days, we think that DSL companies make for an interesting contrarian play.
In selecting the companies we think will benefit from a surge in ADSL use, we've eliminated the larger networking and telecommunications companies such as Cisco (CSCO), Nortel (NT), Alcatel (ALA) and Lucent (LU) whose DSL trans mission businesses represent only a portion of earnings and revenues.
We also cut the DSL modem makers like 3Com (COMS) because analysts say that that business, while attractive for a large player like 3Com in the near term, will quickly become 'commoditized." From there, we pared down a short list of relatively pure DSL plays to two: Orckit and PairGain.
Orckit is the riskier of the two, but it probably has more upside, as well.
The Israeli maker and designer of modems has struck up partnerships with a long line of blue chip companies including Lucent, Siemens (SMAWY) and Rockwell (ROK). Its relationship with Fujitsu (FJTS), though, is getting it the most attention. The two signed a deal in April with incumbent local exchange carrier, or ILEC, GTE (GTE) to supply ADSL technology to 300 central offices in 16 states. Orckit provided most of the technology and the result will be the largest ADSL deployment to date, say the companies. "They have the core technology and they're partnering with good pe ople," says one analyst.
Of course, the near-term success of the company depends to a large degree on ILECs like GTE signing up ADSL subscribers. Not everyone thinks this is a sure bet. "My feeling is that the deployment will be later rather than sooner," says Robert Goldman of Josephthal and Co., citing the high price and low visibility of DSL access.
The $273 million Israeli company is expected to lose 79 cents per share in 1998. But the small group of analysts that cover the company see it earn ing 67 cents a share next year, and put long-term growth at 37.5% a year. The stock currently trades at 29 times 1999 estimates. That's not cheap, but it's not terribly expensive either if you consider that AT&T was willing to pay $48 billion for a company expected to lose a penny a share in 1999.
There's also the ever-present possibility that a larger player will swoop down and make Orckit an offer it can't refuse. That's what Volpe Brown Whelan's Tim Savageaux is saying about PairGain.
The Tustin, Calif.-based firm is making its move into the ADSL business, having already established a solid position as an HDSL systems provider.
HDSL, which is targeted mostly at business customers, is not expected to grow as quickly as its sister technology, but it gives PairGain a steady stream of revenue as it enters the more speculative world of ADSL.
The stock has languished lately, thanks largely to HDSL pricing pressure and lower earnings estimates, but Savageaux thinks that the current price of 17 is too low. Based on the takeover prices of other telecom equipment players such as Ciena (CIEN) and DSC Communications (DIGI), the analyst has a price target of 27 on the stock. "We're in an area of consolidation," he says.
"And people are going to be deciding really soon whether they're buyers or sellers." Cisco's $240 million purchase of privately held ADSL provider Netspeed in March only heightened the anticipation of further consolidation.
PairGain has developed strong relationships with the region al Bell operating companies through its HDSL business and, despite the stock's recent downdraft, it is still expected to increase earnings 9% this year to 74 cents a share. Long term, analysts see the company growing 30.5% a year. At 46% off of its 52-week high, now might be the right time to get in. That is, before the DSL revolution really gets going.
(For more information and analysis of companies and mutual funds, visit SmartMoney Interactive at smartmoney.com
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<..is there an xdsl analyst you think is on top of it?..>
Dataquest has put out some pretty good research pieces, IMO. |
