PAIR was also upped from neutral to a strong buy today; I think it was formerly neutral. According to this article PAIR has the best ADSL technology and so if you look at what happened to AWRE; only time will tell. It's a takeover target anyhow and so it might get bought at under $20, but at under $10; it's a bargin.
Mar 11, 1999
Telecom:Screening for Telecom Equipment Takeover Targets
Analyst: Chris Bulkey
The telecommunications industry has seen a barrage of consolidation in the past year. The
industry is becoming ultra-competitive, and smaller companies are finding it increasingly
difficult to compete with larger players. As a result, smaller equipment suppliers that have a
capable technology, but lack the distribution and scale economies needed to compete are
being acquired by larger players looking to enter high growth markets.
Data traffic is exploding due, in large part, to the increasing popularity of the Internet. As a
result, corporate networks need to run faster and more efficiently, which is fueling demand
for companies that can offer reliable data networking solutions. Meanwhile the quality of
wireless communications continues to improve due to higher bandwidth in fiber optic cables
and higher capacity infrastructure equipment. In this regard, companies that have viable
bandwidth solutions and high power amplifiers are seeing increased demand for their
products.
The future for telecommunications is for voice, video and data to be transmitted across a
single network. This means that carriers will require faster switches and highly reliable access
products. Rather than develop new technologies in-house, which is costly and time
consuming, larger telecom equipment companies are looking to acquire smaller companies
that possess a focused technological solution. To add more fuel to the fire European carriers are trying to keep pace with the
U.S. telecom companies, so they too have joined the buying spree.
On the Prowl
A common scenario is for a smaller company to buy a privately held concern, which then makes them even more attractive to
a larger company looking to enter fast growing markets.
Recently, Applied Micro Circuits (NASDAQ:AMCC - news) agreed to buy privately held Cimaron Communications for
$115 million in stock. In a bigger deal, Intel (NASDAQ:INTC - news) agreed to buy Level One Communications
(NASDAQ:LEVL - news) for $2.11 billion. Level One's data networking chip capabilities further Intel's strategy to enter the
data networking market.
The big guys have also feasted on private concerns. Cisco Systems (NASDAQ:CSCO - news) has bought over a dozen
non-public entities since going public in 1990 and just recently Alcatel purchased privately held Assured Access Technology
shortly after announcing the purchase of Xylan (NASDAQ:XYLN - news) .
A high profile acquisition that really got the ball rolling occurred last June was when Northern Telecom (NYSE:NT - news)
purchased Bay Networks for $9 billion. Last fall, Tellabs (NASDAQ:TLAB - news) failed in its efforts to acquire Ciena
(NASDAQ:CIEN - news) , which will probably fuel future M&A activity.
Tellabs will likely make an acquisition, somewhere down the road, to help round out its ATM (Asynchronous Transfer Mode)
broadband strategy, while Ciena's top-notch DWDM (Dense Wave Division Multiplexing) technology makes the company an
attractive takeover candidate.
The frenzy continued with Lucent's (NYSE:LU - news) $20 billion purchase of Ascend. Lucent's willingness to pay 13 times
sales for Ascend's ATM capabilities demonstrates that companies are willing to pay top dollar to expand in the data
networking market. The $2 billion purchase of Xylan by French telecom company Alcatel (NYSE:ALA - news) lends
credence to the fact that European carriers are eager to enter U.S. markets.
Recently, Siemens (NASDAQ:SMAWY - news) and Philips Electronics made announcements that show that the frenzy isn't
over by a long shot. It was reported that Siemens is ready to make a series of acquisitions beginning with the purchase of
3Com's (NASDAQ:COMS - news) data networking unit.
Meanwhile Philips has made a tender offer to purchase chipmaker VLSI Technology (NASDAQ:VLSI - news) for $17 a
share. It looks like this is going to be a hostile takeover, as Philips will look to replace VLSI's Board of Directors should they
attempt to block the proposal.
Where the Action Is: ATM Switching Technology
So what are the hot areas for 1999? ATM switching technology is quickly becoming the standard that is taking data
networking to a whole new level. According to Computer Telephony Magazine 'ATM is the only way to integrate multimedia
applications.'
The feedback I have gotten from industry analysts is that ATM switching technology will allow for the convergence of voice
and data on a single platform. A company with significant ATM Technology appearing on our list is TranSwitch
(NASDAQ:TXCC - news) . Fore Systems (NASDAQ:FORE - news) and Newbridge Networks (NASDAQ:NN - news) ,
both of which failed to make the list, also have ATM product lines.
A battle is currently being waged, between cable modems and ADSL (Asymmetric Digital Subscriber Line) technology, to
become the preferred medium in which Internet services are delivered to business and household subscribers.
The two main suppliers of cable modem hardware are General Instrument (NYSE:GIC - news) and Scientific Atlanta
(NYSE:SFA - news) , both of which have other businesses, including set-top boxes, which make them less attractive as
takeover candidates.
There are; however, a few smaller component suppliers within the ADSL market that could be attractive. Pairgain
Technologies (NASDAQ:PAIR - news) , which made our list, has perhaps the best ADSL technology. Aware
(NASDAQ:AWRE - news) and Westel Technologies (NASDAQ:WSTL - news) are two companies that did not make our
list (because they did not meet the screening criteria detailed below).
The increasing volume carried over corporate networks is putting a premium on high-speed switches with the capacity needed
to reliably access critical data. Three-layer switching is one such solution. Xylan, is a leader in this area, is being acquired by
Alcatel for $2 billion, or 10 times sales. The steep multiple paid by Alcatel rivals the multiple of 13 times sales Lucent dished
out for Ascend.
Xylan and Bay Networks, both of which have been acquired, are the two most attractive publicly traded players in this area.
There are, however, several privately held concerns that may come public in the future. Keep your eyes open for existing
companies that announce a plan to enter the three-layer switch market and any relevant IPOs (as they will likely be well
received).
Finally, application specific semi-conductors with ultra-fast processing speeds and high reliability are becoming increasingly
important. Alcatel's purchase of VLSI and Intel's take-over of Level One (NASDAQ:LEVL - news) illustrate the importance
of having high-power semiconductor capabilities. Two specialized chipmakers that did not make the list are Vitesse
Semiconductor (NASDAQ:VTSS - news) and PMC-Sierra (NASDAQ:PMCS - news) .
Trying to predict the next takeover is a daunting task, but we have compiled a list of companies that operate in important
niches of the telecom equipment sector, and have fundamental characteristics similar to previous targets. Using the appropriate
Industry and SIC codes we screened the Market Guide database to uncover some possible candidates.
Screening Criteria
We first limited market capitalization to between $250 million and $5 billion, which left us with 103 companies.
We then qualitatively removed companies that did not fit into the appropriate niches of the telecom equipment sector. We then
screened the remaining 60 candidates for fundamental criteria similar to previous takeovers. We demanded that the
price-to-sales ratio be less than 13 times, as no company is likely to warrant an Ascend-like valuation.
Because a leveraged balance sheet makes a company less attractive as a takeover candidate we looked for companies with a
debt to equity ratio below 50%, as well as a current ratio of at least 2.0 to ensure adequate solvency levels.
Finally we don't want companies whose products aren't selling well, so we demanded a 20% sales increase in the most
recently completed year. If a niche player has high sales growth, but limited scale it becomes attractive to a larger company
that can gain leverage and boost margins and earnings.
Please note that these are merely ideas based on quantitative data, and we have no insider information. Therefore, we suggest
that readers use the following table as a starting point for further research.
Price to Sales
Debt/Equity Ratio
Current Ratio
Sales Change %
NAME
(per share, TTM)
(MRQ)
(MRQ)
(Most Recent FY)
Advanced Fibre Communic.
2.33
0
6.2
105.74
Alpha Industries, Inc.
2.8
0.03
2.72
37.1
American Xtal Tech., Inc.
5.81
0.2
4.99
56.13
Applied Micro Circuits
9.81
0.07
7.02
33.32
CIENA Corporation
5.16
0
6.11
22.96
Com21, Inc.
7.79
0.03
8.03
1,464.90
Dallas Semiconductor
3.15
0
4.66
27.69
Digital Microwave Corp.
1.45
0.01
3.71
46.92
Excel Switching Corp.
7.96
0.01
6.11
42.99
Galileo Technology Ltd.
8.82
0
10.93
464.92
Harmonic Lightwaves, Inc.
3.05
0.01
2.92
22.25
Int'l Network Services
7.76
0
2.84
70.92
Lattice Semiconductor
5.34
0
7.09
20.48
Micrel, Inc.
6.71
0
3.67
57.23
Mitel Corporation
0.87
0.43
2.19
27.75
NeoMagic Corporation
1.37
0.01
3.22
205.58
PairGain Technologies
2.34
0
6.54
37.38
Power Integrations, Inc.
4.18
0.1
3.52
92.08
Powerwave Technologies
4.31
0.01
5.06
98.42
REMEC, Inc.
2.36
0
10.13
31.63
RF Micro Devices, Inc.
10.84
0.23
2.36
57.45
Semtech Corporation
3.87
0
5.4
43.6
TEKELEC
3.47
0
3.45
73.5
TranSwitch Corporation
10.3
0
4.78
37.83
Unitrode Corporation
2.73
0
5.47
33.01
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