Cable Tech

Needham Sees Green in Zhone

Is the perennially acquisition-hungry cash burner Zhone Technologies Inc. (Nasdaq: ZHNE) about to turn into a profitable broadband powerhouse?

As surprising as it sounds, that's what analysts at Needham & Co. seem to think.

Needham analysts Eric Kainer and Anton Wahlman say Zhone's recent merger with Paradyne Networks Inc. (Nasdaq: PDYN) will drive it to profitability for the first time in the company's history. (See Zhone to Buy Paradyne for $184M.) They are increasing their estimates for Zhone’s 2005 revenues from $122 million to $154 million and its 2006 estimates from $153 million to $255 million (Ed note: Needham's note actually cited these numbers as "EPS," but given the company's combined revenue of $250M, this appeared to be a typo.)

“This merger has created a DSL/access powerhouse,” wrote Kainer and Wahlman in a report issued Friday morning. The analysts also upgraded Zhone’s investment status from Hold to Buy in the report, citing good developments in the company’s acquisition of broadband equipment vendor Paradyne.

Although the analysts acknowledged that the current valuation is "not ultra-cheap by any means," they set a new 12-month price target at $3.00.

"The stock is currently near a market cap of $375 [million],” the analysts wrote. [Ed. note: According to data provider Capital IQ, the market cap is currently cited as $245 million.] “We believe that a conservative fair value market cap is close to $450 [million].”

If, as Needham predicts, Zhone were to be profitable, it would be quite a turnaround for a company that burned through nearly $500 million in borrowed money before finally finding a way to make money -- apparently by buying Paradyne.

It may finally mark the first successful acquisition by Zhone, after the serial acquirer seemed to be going nowhere buying troubled companies like Gluon, Sorrento, and Tellium. The acquisition of Tellium even caused some controversy when executives in that deal were given a fat payoff. (See Zhone to Buy Paradyne for $184M, Zhone Regroups With Gluon, Zhone to Buy Gluon Scraps, M&A's New Currency, Did Founders Profit on Zhone Loans?, Zhone Gets a Symbol (and Layoffs), Zhone's Strange Saga, and Exec Payoffs Dog Zhone/Tellium Merger.)

The analysts cited Paradyne’s “fairly consistent” financial performance, with its steady addition of small new customers and a diverse base, as the main reason for Friday’s upgrade.

“We are assuming some expense synergies, but believe that our model has more upside potential as the 'new' Zhone unfolds in coming months.”

The analysts also alluded to Paradyne’s recent establishment of a research and development center in China as a chance for Zhone to generate major new revenue in 2006 and 2007. The center is not included in Needham’s current model, but the analysts said they expect upside potential when Zhone management explains their intentions with this asset.

Still, it is unclear from the report why they decided to upgrade the controversial company now, after three months of unstable performance. Zhone’s price per share -- which has been fluctuating since the merger announcement swelled it to $3.57 in July -- had sunk to a low of $2.40 in the month of September.

Neither Kainer nor Wahlman could be reached for comment.

— Joseph Tuzzo, special to Light Reading

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