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Optical/IP

LR Names Best Investment Finalists

Last year, at The Light Reading Telecom Investment Conference, we discussed some theories as to why the telecom market would continue its comeback -- including the deployment of new services, applications, and capital spending. (See Telecom: The Next Generation). Now it's finally happening.

Looking over our picks for Leading Lights Best Investment Potential finalists, we discovered they all have something in common on their stock charts: They're pointing up. For the first time in a long time, there is some real excitement in certain areas of telecom -- including new applications such as digital multimedia, VOIP, and wireless networking. Capital spending is increasing again, after a long drought.

Light Reading editors and Heavy Reading analysts combed through the entries in the Leading Lights Award category for Best Investment Potential and looked for companies that have an opportunity to establish themselves in emerging markets -- or otherwise represent a good value.

Our judges considered factors such as where the companies stood in their product category, how macro telecom trends would effect their business, whether or not the company is profitable, and where it could possibly go from here.

Valuation? Yes, of course, it’s a consideration. But admittedly, we’re not hard-core beancounters. In technology markets, big trends and market positioning are often more important than valuation (think Google). More importantly, we looked for companies with an upward trajectory.

So here’s the list of finalists in the Investment Potential category:

  • ADVA Optical Networking (Frankfurt: ADV):

    Nominated last year, ADVA gets our special international investment pick. That’s because it only trades on the German markets, with tickers listing on the Frankfurt and the XETRA exchanges. ADVA is a solid company that is well positioned in two growth markets -- Ethernet and metro optical networking. (See The Optical Side of Storage, ADVA Snaps Up Covaro, Arvig Uses ADC for FTTx, and Brian Protiva, ADVA AG.) The company is growing and it’s profitable, with revenues and profits rising roughly 30 percent year-over-year. (See ADVA Reports Big Q2 Revenues). It also has gross margins in the 50 percent range, well above the industry standard and a signal that the company is doing something right.

    ADVA recently had a market capitalization of about €200 million (US$235M), which just seems darn cheap. With trailing twelve months of sales of about €120 million ($141 million), that gives it a price/sales ratio of less than two. ADVA is getting the “European discount," and we believe if it traded on a U.S. exchange and had more publicity, it would receive a much higher valuation.

    What we expect to happen is this: (1) ADVA will continue to grow. (2) It will eventually seek out a U.S. listing -- even a potential North American IPO -- to gain more currency for potential acquisitions. (3) Its valuation will rise to bring it in line with comparable U.S.-traded companies.

  • JDS Uniphase Corp. (Nasdaq: JDSU; Toronto: JDU):

    This high-flying George Gilder special once traded in the triple digits. It has spent years falling back to Earth, and that’s why we finally like it. $4? Nah. $3? Hmmm. $2? Sure, why not?

    At $2, JDSU now seems worth taking a flyer on. CEO Kevin Kennedy has done a bang-up job cleaning the company up, cutting costs, and moving the bulk of manufacturing to low-cost centers in Asia. (See JDSU Cuts Continue and JDSU Scores a Q4 Hit.) Meanwhile, competitors such as Bookham Inc. (Nasdaq: BKHM; London: BHM) and Avanex Corp. (Nasdaq: AVNX) are saddled with more expensive manufacturing facilities and are running low on cash. JDSU looks likely to win through attrition.

    With the acquisition of Acterna providing a stabilizing base, JDSU has bought plenty of time to plot its way back to growth (see Acterna Finds Redemption). The optical markets will be coming back -- and by some measures are already picking up steam. JDSU trades at a price/sales ratio of 4.5 and in the most recent quarter was still losing money. But it still holds $800 million in cash. It will be a survivor. (See Spinning & Grinning at OFC/NFOEC.)

  • Motorola Inc. (NYSE: MOT): It seems prudent to pick at least one reasonably valued blue-chip technology company for a telecom investment list. Moto, which is an ongoing revitalization project by CEO Ed Zander, has been steadily improving revenue and profits and launching exciting new products, including its RAZR phone and GPON access devices.

    Yes, Motorola is still mostly a handset company, but it’s also got developing business in the PON access segment, and it’s got a solid set-top box business, which may now be more valuable, given 's (Nasdaq: CSCO) move to acquire Scientific-Atlanta Inc. (NYSE: SFA). (See GPON RFP Weighs In, Archiving Adds Value to Old News, Microsoft Soups Up the Set-Top, and Moto Gains on Nextel Shares.)

    Motorola’s third-quarter earnings more than tripled on record sales, hitting $1.75 billion, or 69 cents per share. With a trailing price/earnings ratio of 15 and a price/sales ratio of about 1.7, Motorola, along with ADVA, is one of the cheapest stocks on our list of finalists. We think this is a healthy company whose turnaround story will continue to play out.

  • NeuStar Inc. (NYSE: NSR):

    The most interesting thing about NeuStar is that nobody is paying attention to it, even though it was one of telecom's few exciting IPOs in 2005. (See NeuStar Twinkles on Wall Street.) Shares have steadily climbed since then and are now 30 percent higher.

    NeuStar is nicely positioned to take advantage of all the growth markets in telecome: VOIP, wireless, and IP-based networking. The company aids with the portability of phone numbers, across both wireless and wireline service providers, including VOIP services. NeuStar administers several mammoth databases that allow service provides to route calls and exchange phone numbers. Specifically, it's got contracts with North American Portability Management LLC; North American Numbering Plan Administrator (NANPA); and the National Pooling Administrator (NPA). The NANPA and NPA contracts reside with the U.S. Government.

    The numbers support the story: NeuStar is growing fast and it's profitable. (See NeuStar Expands in Q2.) Its year-over-year growth rate is about 40 percent. With a forward price/earnings ratio of about 35, the stock is not that expensive. The company has a market capitalization of about $2 billion, but it's easy to see how it could get a lot bigger.

  • Redback Networks Inc. (Nasdaq: RBAK):

    Redback’s staged a remarkable recovery. Just a couple years ago, it was wallowing in debt, falling behind in product leadership, and bleeding people and money. But after its restructuring, it appears to have gotten its act together and is now one big deal away from profitability.

    The SmartEdge series of edge routing and subscriber management products have been retrofitted with features such as session-level reliability and Ethernet aggregation, making them optimal for video and triple-play networks -- a big factor in Redback’s recent wins, including the monster deal at (NYSE: BLS). (See Routers Answer IPTV Call and How Redback Won BellSouth.) Sources say such contract wins are likely to continue.

    Redback was recently trading at a price/sales ratio of about 5 and had a market capitalization of about $700 million. No, that's not cheap, and this is probably the riskiest stock on our list. But Wall Street's analysts have lagged in upgrading their spreadsheets from Redback's recent wins; if the company can land some more big deals, it’s likely analysts will have to continue to increase their revenue and profit estimates. Recent buying interest in Redback from heavy hitters in the investment community bodes well. (See Redback Boosted by TCV, Verizon Talk and Redback Shares Rock: What's Up?)

    Bottom line? We like the action in Redback shares, and a nice sized deal at (NYSE: VZ) would help the stock. At the very least, it’s an obvious acquisition target. (See Tellabs May 'Edge' Towards Redback and Redback's DeNuccio: We Can Go It Alone.)

    — The Staff, Light Reading

    (In keeping with Light Reading policy, editors and analysts do not buy or sell stocks about which they write.)




  • For more information on the Leading Lights Awards, click here.

  • For more information on The Light Reading Telecom Investment Conference, click here.

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