ADC Takes a Hit
The purchase of access equipment firm Krone Inc. for $350 million earlier this year had the desired effect on ADC Telecommunications Inc.'s (Nasdaq: ADCT) revenues. They did go up (see ADC Cuts Loss in Q3 and ADC Jumps on Krone). But the healthy top line didn't soothe analysts' concerns about the impact on profitability.
ADC recorded a net loss of $14.3 million, or 2 cents per share, from revenues of $235.2 million in the third quarter, a significant improvement on the loss of $26.6 million from revenues of $182 million in the second quarter of this year. It was also an improvement from a year earlier, when the vendor lost $15.1 million from revenues of $188.6 million.
ADC is expecting revenues of between $250 million and $260 million, and earnings per share of $0.01 to $0.02, in the fourth quarter, in line with analyst expectations.
Analysts, though, had estimated earnings of 0 cents per share for the third quarter. And the share price fell by 19 cents, more than 8 percent, to $2.06 this morning.
Jefferies & Co. analyst George Notter is displeased by the impact Krone has had on ADC's bottom line. "We're disappointed by the apparent lack of profitability in Krone," he writes in a research note. ADC's numbers show that the operating profits in its Broadband Infrastructure and Access (BIA) line of business were slightly higher, at $20.2 million, than the previous quarter's $19.5 million, but Notter feels they should have been boosted much more by the inclusion of Krone sales.
For Notter, this serves to "suggest that profitability in the Krone business dropped" on a quarter-by-quarter basis. He writes that Krone may have been "prettying up its March quarter results in advance of the ADC acquisition in May" or it could show that something is "structurally wrong or different with Krone that is creating a lower margin structure."
As a result, Notter is being far more cautious about the positive impact Krone could have on ADC's numbers, and the Jefferies team has reduced its rating on ADC's shares from Buy to Hold. In addition, Notter has also cut the EPS estimates for fiscal 2004 from $0.03 to $0.01, and for fiscal 2005 from $0.11 to $0.10.
But that at least puts ADC back in the black after years of losses. The company has transformed itself from a diversified telecom business to one with a tighter focus on access technologies, particularly fiber access (see ADC Beefs Up DSL Products and ADC Showcases at Supercomm). Spurred on by its involvement in Verizon Communications Inc.'s (NYSE: VZ) FTTP plans (see Verizon Doubles FTTP Supply List), ADC has notched up a number of other fiber-to-the-whatever deals (see NTS Deploys ADC FTTP, Home Town Cable Deploys ADC FTTP, and FTTH Comms Picks ADC Gear).
Notter notes that "FTTP is an important growth opportunity," and that ADC's management had claimed 20 carrier customers for the firm's fiber distribution and fiber access terminals for FTTP. But he adds that gross margins from FTTP gear sales have been low, and that overall margins might take a hit as FTTP revenues ramp up.
ADC has also been busy in the test and measurement arena, launching products and opening test facilities (see ADC Launches Ethernet Test Tool, ADC Opens DWDM Test Facility, ADC Opens in U.K., and Verizon Approves ADC Test Lab).
The company's transformation has also seen it involved in various M&A activities this year. As well as buying Krone, which has given it a broader product portfolio and strengthened its international operations, ADC has sold non-core assets, including its billing systems business and a cable system unit (see BigBand Buys ADC's IP Cable Unit, Intec Buys ADC Billing Unit, and ADC Tries Flogging its OSS).
But it still hasn't managed to sell its wireless network performance management business, Metrica. Sector analysts are surprised that its fate has not yet been determined, especially as it continues to renew contracts and win new business as mobile operators launch their 3G networks. (See Qtel to Deploy ADC's OSS, Swisscom Mobile Deploys ADC, and ADC's Metrica Gets Into China Mobile for just a few recent examples.)
The sale of that business is expected to net ADC between $30 million and $40 million, according to Morgan Keegan & Company Inc. analyst Simon Leopold (see ADC Close to OSS Sale). But the longer it takes to sell Metrica, the harder it will be to get a decent price for the software business, says OSS Observer analyst Mark Basham. [Ed. note: Basham? I hardly know 'em.] Metrica is "a sound business with a good customer base, but maybe ADC is asking too much for it. And the longer it holds onto the business, its value is likely to be eroded, as any business unit needs focus and investment to stay strong," Basham says. "As a non-core asset it may not be getting that, and that would impact its value and possibly the morale of the staff."
Who might buy it? The analyst hasn't heard any rumors, and says that although a management buyout is a "possibility, the team would still have to find backers, and there's been no evidence of any interest from VCs or investment bankers."
ADC says there's nothing to report regarding the sale of the Metrica business, but that the company is looking to make an announcement regarding its future by the end of the financial year in October.
— Ray Le Maistre, International News Editor, Light Reading
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