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NN: NEWBRIDGE NETWORKS Update: Full Steam Ahead
BancBoston Robertson Stephens - November 19, 1998
Paul Silverstein
Key Points:
* We believe that Newbridge will once again meet Street consensus earnings estimates for the second quarter of 1999 (which closed on the last day of October). In addition, we expect to see continued balance sheet improvement in terms of DSOs, inventory turns and cash on hand.
* We believe that Newbridge has been selected by Deutsche Telekom, France Telecom and Global One for substantial infrastructure build-outs. We estimate these awards will generate over US$500 million in revenue to Newbridge over the next three to five years.
* Newbridge reports its Q2 1999 on Tuesday, November 24, 1998.
This note discusses the following:
* Our expectations for Newbridge's fiscal second quarter of 1999;
* A series of significant contracts we believe the company has won and will shortly announce with Global One, France Telecom and Deutsche Telekom;
* The continuing management changes effected by Alan Lutz;
* New products introduced by the company; and
* The state of the Siemens-Newbridge alliance.
A more complete discussion of the changes effected since the arrival of Mr. Lutz, Newbridge's new President and Chief Operating Officer, on June 2, 1998--- which updates our earlier report entitled "Shouting into the Wind," dated July 27, 1998--can be found in our report entitled "The Voice in the Wilderness," dated November 17, 1998.
These changes are taking hold from the very top of the organization down to the rank and file; and they are both substantive and intangible. With regard to Newbridge, quite simply stated, CHANGE IS GOOD. At a very fundamental level, the principal change that has been effected by Mr. Lutz is a sense of accountability to the ultimate stakeholders of the company---it's public shareholders. To this end, we note that Mr. Lutz has invested his own money in Newbridge's stock, having recently purchased 10,000 shares.
Q2 1999 Operating/Financial Performance
Regarding Newbridge's ability to profitably grow its business and to deliver the operating results demanded by investors, the company has delivered two consecutive quarters in which it has met consensus expectations after a long, painful period for investors in which the company overpromised and under- delivered. We believe that Newbridge will once again meet Street consensus earnings estimates for the second quarter of 1999 (which closed on the last day of October). In addition, we expect to see continued balance sheet improvement in terms of DSOs, inventory turns and cash on hand.
We believe that in spite of having to date largely missed the huge opportunity presented by the burgeoning alternative emerging service providers, Newbridge's WAN packet business in general, and the 36170 platform in particular, will continue to register impressive sequential growth. Over the next four quarters, we expect this growth to be approximately 50-60%. We note, however, that the bulk of this growth should be weighted toward Newbridge's fiscal third and fourth quarters of 1999. First, Newbridge introduced its newest release, 3.1, of the 36170 during its fiscal Q1 1999. We believe that consistent with other new product releases, it will take a couple of quarters for this release to fully ramp. In addition, the large multiservice switch infrastructure awards to Newbridge over the past 12 months should continue to ramp. Thus the revenue stream from these awards should gain momentum with each passing quarter.
Customer Wins
We believe that Newbridge has been or is about to be awarded separate contracts by Global One (the consortium owned by Sprint, Deutsche Telecom and France Telecom), France Telecom and Deutsche Telekom for the build-out of a next-generation core WAN packet infrastructure based on Newbridge's flagship 36170 ATM Multiservices Switch. Together with the France Telecom and Deutsche Telekom contracts discussed below, along with Newbridge WAN infrastructure deployments by over 100 affiliated service providers in which one or more of Global One, France Telecom and Deutsche Telekom hold equity interests, we estimate the size of this award to be over US$500 million over an initial three to five year timeframe. We expect that one or more of these awards will be announced on Tuesday, November 24, 1998, to coincide with the release of Newbridge's earnings for its fiscal second quarter of 1999, with the other announcements to follow shortly thereafter. In connection with the Global One, France
Telecom and Deutsche Telekom awards referenced below, we also believe that Newbridge is well-placed to secure an award by Sprint as part of Sprint's next-generation WAN packet build-out.
We also believe that Bell South International has selected Newbridge's 36170 and other Newbridge equipment for its switching infrastructure in the foreign service providers in which Bell South owns a controlling equity interest, which are located predominantly in South America and Asia-Pacific. We believe that this award, which has not yet been formerly announced, could amount to over $100 million over the life of the contract.
Other potential large future awards include: Winstar, the nationwide wireless fiber CLEC, which would involve the 36170 in an LMDS application; and additional business from Cable & Wireless if C&W proves successful in securing U.S. fiber capacity and expanding its U.S. presence, which it currently appears intent on doing.
Management
Since his arrival, in a measured and deliberate manner, Mr. Lutz has been revitalizing the management ranks of the organization. Lutz entered a company in which the management ranks were replete with executives who were holdovers from the earliest days of the company. Essentially, it is not too much of an exaggeration to say that too many of the managers had been breathing the same stale air---and worse, were getting intoxicated on it. Rather than come in and summarily execute the whole existing cadre of management, which would have proved extremely destabilizing in our opinion, Lutz has been surgically replacing, one-by-one, the top management echelon in the sales and marketing organizations. In an effort to breathe new life and direction into the company, Lutz has recruited their replacements largely from outside of the organization.
Lutz already has replaced five of the top sales and marketing positions in the company; to date, he has filled three of these positions. In each case, Lutz has brought in a seasoned executive with fresh, outside perspective and a wealth of experience. A brief listing of the positions that have changed guards follows:
* Executive VP and General Manager for North and South America: Hired Giulio Gianturco from Cabletron where he was President, Worldwide Channels Development. Previously, Gianturco held the position of Vice President for the Americas and Director of North American Sales and Sales Support at DEC. Prior to DEC, he spent 12 years at Lucent's predecessor, AT&T's Global Business Communications Systems Business Unit.
* VP of US Sales: Currently open. Gianturco will likely be responsible for filling this position.
* Executive VP of the Switching Products Group: Hired Brian Jervis from Nortel, where he worked for over 20 years, most recently as Vice President and General Manager of Multimedia Networking, where he was responsible for Nortel's Passport multiservice data switch platform as well as Nortel's Meridian PBX products. Previously, Jervis held positions at Nortel as Group Vice President, Switching Networks and Senior Vice president and General Manager of Magellan Passport/DPN (Data Packet Networks).
* Executive VP North and South America Marketing: Currently open. Lutz will make this hire.
* VP North and South America Marketing: Recently hired Kay Kienast. Most recently, Kienast was Vice President of Marketing for Cincinnati Bell Information Systems (CBIS). Prior to CBIS, Ms. Kienast held a number of senior and executive marketing positions at Digital Equipment, Bell Atlantic, Dell Computer Corporation and Unisys.
In addition, we expect Lutz to continue to replace additional managers in the organization with fresh, motivated leaders from outside of the company.
Products
Newbridge has introduced a number of new products focused on the WAN access market over the past several months. As the WAN access market continues to accelerate, we expect Newbridge to garner its fair share of this already sizable and rapidly expanding market. Newbridge is focusing its attention on extending its multiservice ATM WAN architecture to the edge of and into the LAN. To this end, Newbridge has been rounding out its core and edge ATM multiservice product offerings with a significant expansion of ATM access products via both internal development and acquisition.
In addition, Newbridge is moving forward with the development of its next- generation upgrade of its flagship 36170 switch.
* 36170 MainStreet Express ATM Multiservices Switch Up-grade The upgrade of Newbridge's flagship 36170 Multiservices Switch is scheduled to ship for revenue around the third quarter of calendar 1999. This substantial upgrade will increase the switch fabric of the 36170 by a factor of four to 51.2 Gbps from its current 12.6 Gbps, and will also introduce significant signaling and traffic management enhancements. We recognize that by being late to recognize and address the opportunity, Newbridge has placed itself at a significant disadvantage vis-a-vis Ascend (ASND $53 7/8 Buy) with next-generation service providers in the US. We note, however, that given the relatively modest expense compared to traditional circuit switch infrastructure, most service providers appear to be more than willing to swap out their existing data networking equipment for next-generation solutions. This sword obviously cuts both ways. To the extent that Newbridge executes on its substantial upgrade of its
flagship 36170 platform, we believe that it is still not too late for Newbridge to make up lost ground. The obvious corollary is that the company will need to be vigilant in defending territories already won.
* 36177 Multiservices Platform: We recently had the opportunity to observ Newbridge's new 36177 Multiservices Platform, which was introduced at Networld+Interop in October. We were very favorably impressed with the extremely footprint of this platform, its new midplane design and its traffic management capabilities. In fact, we believe that this is the most exciting product to come out of Newbridge in a long time. The 36177 addresses two distinct equally large market opportunities. The switch is optimized to serve as an access device into 36170 networks and also to serve as the backbone of private wide area networks. Regarding the latter market, we note that, facing a dearth of competition, Cisco and Nortel have dominated the enterprise WAN ATM switch market.
While we do not expect Newbridge to capture significant market share in the near to intermediate term, given the substantial size of this market---which we estimate will account for approximately $500-750 million, or approximately 25-30%, of the total ATM switch market, in calendar 1998---even a relatively modest market share would translate into material revenue for the company. Newbridge anticipates commercial shipments of the product around the end of calendar 1999. We believe that this product will materially contribute to Newbridge's revenues by the middle of calendar 1999.
* IronBridge's core terabit scale router. A Newbridge affiliate, IronBridge Networks is developing a core terabit scale router. We believe that this product will ship for revenue in the second or third quarter of calendar 1999 and will be integrated with the 36170 and Newbridge's 46020 and 48020 management platforms. In all likelihood, while ATM multiservice switches and big fast routers (BFRs) will coexist, with the former principally deployed in multiservice networks and the latter principally deployed in IP dominated networks, we note that IronBridge contributes to Newbridge's own internally developed impressive IP capabilities. Newbridge's CSR architecture, which purportedly provides an end-to-end means of transporting IP across a WAN and is supported by 3Com as well as Siemens, and now Ericsson (see below) is expected to be shortly introduced into carrier trials.
In addition, CSR incorporates highly acclaimed secure-VPN, VoIP and remote access solutions provided by Newbridge's TimeStep, Vienna and ACC affiliated companies. The internal restructuring of the company's operations into three product focused groups should further enhance the commercialization of Newbridge's IP technologies, including IronBridge's core IP router.
* Cambrian System's Ring-Based OPTera DWDM System. A Newbridge affiliate, Cambrian Systems has developed a ring-based DWDM system optimized for Metropolitan Area Networks (MANs). Cambrian's OPTera DWDM system is in trials with a number of service providers. We expect Cambrian to ship OPTera in limited quantities for deployment in the first quarter of calendar 1999, with revenue recognition to follow in thesecond or third calendar quarter of 1999. In addition to addressing what is widely expected to be a huge market opportunity potentially rivaling the long-distance market over time, Cambrian's OPTera DWDM system when combined with Newbridge's 36170 Multiservices Switch in a distributed configuration offers a significant price-performance increase for delivering applications over MANs. Newbridge owns 40% of Cambrian's outstanding equity.
* 36170 Deployed as LMCS/LMDS Systems. Newbridge has already announced four contracts, three of which are substantial, for the 36170 to be deployed in LMCS/LMDS networks. We are impressed by Newbridge's early recognition and aggressiveness in attacking this market opportunity. Working first with Broadband Networks and then with Stanford Telecom, Newbridge has designed a radio interface card for the 36170 which transforms the 36170 into an effective base station from which to deliver wireless broadband data traffic onto a wireline network. The only other company with a competitive solution set for this market of which we are aware is Nortel.
Over time, Newbridge's worldwide addressable LMCS/LMDS market opportunity we believe will amount to several billion dollars.
* 36140/36144: The 36140 and smaller 36144 were designed by RADnet which was jointly acquired by Newbridge and Siemens last year, and then renamed SeaBridge. These products complement the 36177 and similarly address both the WAN access and private WAN markets. These products are scheduled to ship for revenue around the end of the calendar year.
* 36060 (TLS device): Newbridge OEMs the 36060 from Sonoma Systems, a private WAN access communications equipment vendor. The 36060 has distinguished itself as one of the leading platforms from which to deliver transparent LAN services (TLS). Given the rapid expansion of the TLS market, the 36060 has been a pleasant surprise for Newbridge and a nice complement for Newbridge's access solutions.
The Siemens-Newbridge Alliance
Swirling rumors to the contrary notwithstanding---and this one appears to emerge on a regular basis--we believe that Newbridge's strategic relationship with Siemens is stronger today than it has been in a long time. In short, believe that the relationship has changed to accommodate the concerns of both parties. Most importantly, from the perspective of Newbridge's shareholders, we believe that these changes will redound to their benefit.
Once again, we believe that Alan Lutz has been the driver of this change. The benefits to Newbridge include more direct account control and concomitantly greater overall net margins.
As we have previously noted, even if the Newbridge-Siemens relationship did crater, we believe the news would be far from an unqualified disaster for Newbridge. While Siemens does contribute certain benefits to Newbridge, they are offset by a number of shortcomings. We continue to believe that the ideal relationship with Siemens from the vantage point of Newbridge and its shareholders is a traditional OEM relationship.
Conclusion
What will it take for Newbridge to win converts among the investment community? First and foremost the company will need to perform---to meet and exceed investors' expectations. We believe that Newbridge's business will deliver these results, in both the near-term and the long-term. We expect the second quarter conference call together with the Global One, France Telecom and Deutsche Telekom announcements will significantly bolster investors' confidence and help highlight the changes transpiring within the organization---from replacement of personnel to organizational streamlining to renewed focus and commitment to delivering shareholder results. Indeed, five months into Alan Lutz's tenure, as set forth in our "Voice in the Wilderness" report, we believe that there is already a large and growing body of data points to suggest that Newbridge is a very different---stronger, more focused--company today than it was prior to Lutz's arrival.
For those investors who recognize that Newbridge's past serves as a poor reference point for predicting Newbridge's future, Newbridge currently presents a great investment opportunity, in our opinion.
ACTION NOW: Newbridge is rated a Buy.
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