Redback: How Low Can It Go?

Redback Networks Inc. (Nasdaq: RBAK) is gushing red ink and suffering a bombardment of shareholder lawsuits. But if acquisition rumors pan out, short sellers may soon be blushing.

After Wednesday’s market close, Redback reported a pro forma loss of $37 million, or 26 cents a share, on $59 million revenues for the June quarter. The loss was modestly better than the 29 cents per share loss expected by the consensus of analysts who slashed their numbers after the company issued a warning last month. The pro forma figures exclude restructuring charges, inventory-related charges, amortization of intangible assets, stock compensation expenses, and a research and development charge.

Factoring in those charges, Redback lost $460 million, or $3.26 a share, for the quarter. The company burned $65 million in cash during the quarter and currently has $314 million remaining in cash and marketable investments.

Company officials are treading the line between caution due to poor market visibility and optimism for their products versus their industry peers. “It appears this downturn continues unabated,” said CEO Pierre Lamond. “We expect the downturn to continue through the end of this year… We are the leader in supporting DSL deployments by a large margin.”

With its stock market value down to barely $1 billion, Redback may be attracting suitors. W.R. Hambrecht & Co., which offers a Buy rating, considers the stock “compelling at these levels given the potential for an acquisition by the likes of Alcatel SA [NYSE: ALA; Paris: CGEP:PA], Siemens AG [NYSE: SI; Frankfurt: SIE], or Nokia Corp. [NYSE: NOK],” according to a recent report by the brokerage firm.

The stock slipped to a new 52-week low to close Wednesday at $6.53 a share. In after-market trading, the stock jumped to $7.30. Exactly a year ago, on July 12, the stock hit a 52-week high of $177. About 10 percent of the company’s floating shares are currently sold short.

The plunging share price has been a magnet for numerous class action suits that accuse the company, its executives, and underwriters Morgan Stanley Dean Witter & Co., Robertson Stephens, Lehman Brothers, and Dain Rauscher Wessels, of stock manipulation in connection with the company’s 1999 initial public offering. Such suits have become increasingly common over the last several months, as hot IPO companies of 1999 and 2000 have seen their stock prices plunge.

Redback’s key woes, however, are rooted in the fact that its customers have dramatically changed their purchasing habits. Carriers are now concerned only about immediate bandwidth needs rather than building networks for demand in future years. Several important customers like Williams Communications Group (NYSE: WCG), BellSouth Corp. (NYSE: BLS), Genuity Inc. (Nasdaq: GENU), and SBC Communications Inc. (NYSE: SBC) have pushed back their orders from Redback.

These carriers are moving to a "just in time" strategy of ordering equipment rather than buying it well in advance of installation as they had done in the past, a Deutsche Banc Alex Brown LLC analyst wrote in a recent report. He noted Redback’s earnings shortfall is “very consistent with large earnings misses at Nortel Networks Corp. [NYSE/Toronto: NT] and Tellabs Inc. [Nasdaq: TLAB; Frankfurt: BTLA].”

As carriers continue to slash capital spending, sales of Redback’s SmartEdge 800 optical product for simplifying network architecture have plummeted. SmartEdge sales, which accounted for 40 percent of company revenues, dropped to $24 million for the quarter, compared with $46 million in the March quarter.

Despite such setbacks, company officials expect SmartEdge’s prospects to brighten in the future and account for a majority of revenues. Redback announced earlier this month it had closed a deal with the Chinese Petroleum Corp. in Taiwan to supply SmartEdge for a network alongside its pipelines. Redback pegged the contract as a “multimillion dollar” deal and said it was its largest Asian contract so far.

The company’s Subscriber Management System, currently its biggest product line, connects and manages large numbers of subscribers using any of the major high-speed access technologies including digital subscriber line, cable, and wireless.

In the Wednesday conference call, Redback executives guided analysts to 2001 revenues of $260 million to $300 million. They expect pro forma figures for the third quarter to be “flat to slightly better” than the second quarter, and they predict a 76 cent per share pro forma loss for the year.

Officials did not offer guidance for 2002. But the consensus of analysts forecasts a 29 cent loss for the year.

- Tom Davey, special to Light Reading
http://www.lightreading.com