Optical/IP Networks

Foundry's Fallout

Foundry Networks Inc.’s (Nasdaq: FDRY) stock plunged on Thursday after it reported disappointing third-quarter results the night before (see Foundry Reports on Q3). The news seemed to spook investors in early morning trading, sending Foundry competitors’ stocks down, too. But by mid-afternoon competitors had recovered, while shares of Foundry remained down 1.43 (12.98%) at 9.60.

Wednesday night Foundry reported that it had missed analysts’ consensus expectations for the third quarter of 2001. Revenues for the quarter came in at $74.7 million, down 16 percent from last quarter and missing consensus expectations of $81.7 million.

Its pro forma net income for the quarter was $2.5 million, or 2 cents per share. Analysts polled by First Call had expected net income of 5 cents per share, with individual forecasts ranging between 2 cents and 7 cents. Results were also way off from last year's third quarter, when the company reported pro forma net income of $28.6 million or 23 cents per share.

Several analysts downgraded the stock today in their notes issued to investors. Salomon Smith Barney analyst Alex Henderson, in fact, took the unique and counter-intuitive approach of downgrading the stock while at the same time raising his price target. In a research report, Henderson cut his rating from Buy to Outperform, while raising the target price to $12 from $10.

Need an explanation? Henderson says the company is caught in the difficult economic environment. The rationale behind downgrading the stock and raising the price target is that even though the company has made some "strategic mis-steps," it has a valuation that is "among the lowest in the category" and thus warrants a higher price.

Samuel Wilson, of Merrill Lynch & Co. Inc., also cut his midterm rating on Foundry to Neutral from Accumulate. And he cut his 2001 earnings estimate to 16 cents a share from 21 cents and his 2002 estimate to 23 cents a share from 31 cents.

In his note, Henderson points out that the problems with Foundry seem to be more company-specific than industry-wide. While other companies -- Extreme Networks Inc. (Nasdaq: EXTR), for instance -- have cited September 11th as a problem, Henderson says that Foundry’s problems are more specific [and probably only tangentially related to the Taliban's support for Al Qaeda -- ed.] (see Extreme's Extremely Inconclusive Quarter). The biggest problem he sees is that the company seems unfocused, at the moment, on which market to address. It has been heavily oriented toward the ISP/ASP market and has wasted time and effort trying to attack the core routing market, but now the company says it is trying to shift resources to address the enterprise and metropolitan area markets. Secondly, Henderson notes that Foundry is in a down cycle with regard to its product development, with new products not expected to be introduced to the market until the second half of 2002.

On the flip side, competitors like Enterasys Networks Inc. (NYSE: ETS), the enterprise spinoff of Cabletron Systems Inc. (NYSE: CS); Riverstone Networks Inc. (Nasdaq: RSTN), Cabletron's metro spinoff; and Extreme are all in better positions right now, says Henderson (see Riverstone Makes its Numbers).

The biggest stumbling block for Foundry this quarter was in Asia. While Riverstone and Extreme have seen growth there this quarter, Foundry suffered its biggest losses internationally, with revenue dropping 30 percent quarter-over-quarter to $24.6 million this quarter. China Telecom made up a significant portion of its international revenue in the second quarter with a big purchase order. Analysts said that with such a big deployment, the carrier was still absorbing the equipment in the third quarter and therefore wasn’t buying or installing new equipment. Henderson says he doesn’t expect revenue from China Telecom to pick up in the fourth quarter and cites this as another reason for his downgrade of the stock.

— Marguerite Reardon, Senior Editor, Light Reading
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