Sorrento Picks Up Brokerage Coverage

Helping move Sorrento Networks Corp. (Nasdaq: FIBR) out of the hinterlands of Wall Street stock coverage, a second investment bank has started covering the company.

Analysts at Robert W. Baird & Co. Inc., a brokerage based in Milwaukee, have picked up coverage on Sorrento. In a report issued this week, analysts wrote that there is "tremendous upside" for the company if it can work out its financial troubles and come through with a big carrier customer. The firm gave Sorrento's stock a Market Perform rating, its third-highest out of five possible ratings. The report also dubbed the stock a "speculative risk" and gave the stock a price target of $12.

Baird is only the second brokerage house to provide research coverage of Sorrento. The other firm is The Chapman Company, a Baltimore-based investment bank that has held a Strong Buy rating on Sorrento since December 14, 2000. At that time, Chapman put a price target of $160 on the stock. On May 30, 2001, Chapman reiterated its Strong Buy rating, but its price target for Sorrento is now at $30.

Sorrento shares got a small boost from the action, jumping 0.48 (5.83%) to 8.71 in late afternoon trading on Friday.

Light Reading has also learned this week that several investment banks are busily conducting due diligence on Sorrento. The company is trying to raise between $15 million and $30 million in new funding, according to people familiar with the situation.

Sorrento's attractive qualities include its technology and the fact that it has 24 customers, the Baird report says. These customers include AT&T Broadband, Cox Communications Inc. (NYSE: COX), Deutsche Telekom AG (NYSE: DT), United Pan-Europe Communications NV (UPC) (Nasdaq: UPCOY), and Inrange Technologies Corp. (Nasdaq: INRG) -- the five companies that represented 75 percent of its first-quarter 2002 sales. The report also says Sorrento was "in field trials with three carrier class customers and we believe a contract announcement should result within a couple of months, once financial issues are resolved."

The report also notes that Sorrento's GigaMux metro DWDM product has a high overall capacity (640 Gbit/s) and can multiplex 64 protected channels onto a single fiber. This compares favorably with products from Ciena Corp. (Nasdaq: CIEN), Cisco Systems Inc. (Nasdaq: CSCO), Tellabs Inc. (Nasdaq: TLAB; Frankfurt: BTLA), Nortel Networks Corp. (NYSE/Toronto: NT), ONI Systems Inc. (Nasdaq: ONIS), and Sycamore Networks Inc. (Nasdaq: SCMR).

But before Sorrento can attempt to take market share from its competitors, it must wrangle with two key financial issues. First, Sorrento must resolve a dispute it has with its preferred shareholders. The preferred shareholders have filed to sell their shares, but Sorrento says it doesn't have a legal obligation to pay up since it can only redeem those shares using "positive retained earnings and capital surplus."

The second issue is that Sorrento could use some cash. Baird's analysts estimate that Sorrento has about $5 million in cash, while the company's burn rate is between $2 million and $2.5 million a month. The company has about $30 million in marketable securities or investments that could be sold for cash. It also has credit facilities totaling $8 million, of which $1.3 million has been drawn down.

Sorrento has yet to secure the $15 million debt financing from Silicon Valley Bank that it spoke of during its May 23 earnings conference call.

Raising money is a crucial thing for Sorrento, because its lack of cash might cause a potential customer to turn tail, says Baird analyst Dan Shin, who, along with analyst Ted Moreau, wrote the report. "If you're a big carrier, you want to be sure that a supplier is going to be around to service you for a couple of years," Shin says.

Besides its financial plight, Shin sees some potential for Sorrento's technology. His firm’s opinion is that the company's low valuation compared to its peer group might make it an acquisition target.

The Baird report compares Sorrento’s valuation to ONI Systems, a more highly valued metro DWDM pure-play. Sorrento has been in the metro DWDM space much longer than ONI, but the company is only about half the size. And, while ONI carries a $2 billion-plus valuation, Sorrento's valuation is in the $100 million range.

It's no fluke that ONI is a more valuable company than Sorrento, and its easy to see why Baird suggests Sorrento as an acquisition target. Sorrento's revenues were $13.1 million last quarter, a company record. ONI's revenues were $45.1 million during its most recent quarter; and it had $799.1 million in cash and cash equivalents as of March 31.

"Given [Sorrento's] strong engineering and product leadership with relatively low valuation, the company would be an attractive acquisition target for a larger incumbent optical networking vendor wanting to get into the metro market," the report says.

- Phil Harvey, Senior Editor, Light Reading
http://www.lightreading.com