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Stock Watch: Extreme Networks

Can shares of Extreme Networks Inc. (Nasdaq: EXTR) scale to new heights?

Good question. Much of it depends on whether the company can take its position in the Layer 3 Ethernet switching market and extend it to new markets, including the metropolitan area networking market.

Extreme Networks is the leading provider of Layer 3 Ethernet switches, with a 30 percent market share, based on port shipments. The company dominates the market for stackable Layer 3 switches at the enterprise level. Analysts expect fiscal 2001 (ending June) sales to rise 140 percent, to $630 million, and fiscal 2002 sales to top $1 billion. Earnings are expected to jump 132 percent this fiscal year, to 51 cents a share, and nearly double again in fiscal 2002. Extreme holds the top spot in the stackable Layer 3 switch market, with a 60 percent share, according to The Dell'Oro Group. Rivals Cisco Systems Inc. (Nasdaq: CSCO) and Foundry Networks Inc. (Nasdaq: FDRY) combined account for less than 16 percent of the market. However, in the higher margin, chassis-based LAN switch market, Cisco rules with a 46 percent share, while Extreme has less than a 5 percent share.

In the latest quarter, sales to service providers represented just 25 percent of Extreme's total sales, but analysts expect this figure to be close to 40 percent within the next two quarters.

Sequential revenue growth has averaged nearly 26 percent in the past two quarters. On the strength of a 38 percent sequential increase in earnings per share in the latest quarter, shares of Extreme have rebounded nearly 80 percent in the past month.

The Layer 3 switch market is now a $3 billion business, expected to grow to between $4 and $5 billion by 2002. But according to ABN AMRO communications equipment analyst Kenneth Leon, the market will begin to mature during the next two years, and, as it does, pricing pressure will weigh more heavily on margins. In order to stay competitive, Leon says Extreme will need to focus more on the fast growing Layers 4-7 market.

Software-based Layers 4-7 switches, which offer higher margins, have more functionality and are better suited for tasks such as load balancing. Estimated to be just a $250 million market in 1999, it is expected to grow to $2.5 billion by next year, as ISPs and Web content providers increasingly deploy these switches in their networks. Analysts say load balancing alone could be a $2 billion market by 2004.

Extreme is now shipping switches with Layer 4 load-balancing functionalities, using software licensed from F5 Networks Inc. (Nasdaq: FFIV); the company is in the process of developing a stand-alone product. Besides Foundry, both Cisco and Nortel Networks Corp. (NYSE/TSE: NT) are now major players in Layers 4-7 switches, with their acquisitions last year of Arrowpoint and Alteon WebSystems, respectively. Extreme is broadening its business by increasing its focus on service providers. Analysts say 10-gigabit Ethernet will provide the next major surge of growth for Ethernet switch vendors during the next few years as Ethernet is slowly adopted by service providers in metropolitan area networks (MANs). It’s estimated that 10-Gbit/s Ethernet could be nearly a $4 billion market by 2004. Extreme is already shipping a 10-Gbit/s Ethernet product to both service providers and enterprises. It’s expected to deliver products that comply with new 10G standards by the second half of this year.

Extreme was recently trading at 50. Its 52-week range is 21.19 to 128.88.

-- Rob DeFrancesco, special to Light Reading http://www.lightreading.com
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