Story URL: http://news.medill.northwestern.edu/chicago/news.aspx?id=163096
Story Retrieval Date: 7/31/2014 6:40:23 PM CST
Having one foot mired in legacy business and the other inching toward next-generation products, telecommunications equipment provider Tellabs Inc. has drawn mixed reactions from Wall Street. Do you buy? Or do you hold? Analysts' ratings of the stock are mixed.
On the rosy side, Robert W. Baird & Co. stated in a February report, “With growth products now [approximately] 50 percent of revenue and gaining momentum, Tellabs’s top line appears likely to reaccelerate, albeit slowly given the drag from legacy products.”
Of 17 analysts surveyed by Bloomberg LP, only one gives the stock a sell rating while the remaining 16 split evenly between buys and holds. Nevertheless, the consensus target price for the stock is only $7.72, considerably below its 52-week high of $8.53 reached on Wednesday.
Analysts estimate earnings for this year at 32 cents per diluted share, compared with the 29 cents per diluted share earned last year. Revenue for the fiscal year ending in December is expected to be $1.57 billion, a slight increase from last year’s $1.53 billion.
In 2009, more than half of Tellabs’s revenue came from sales of equipment nearing the end of its product lifecycle, such as the 5500 Digital Cross-Connect, used for switching Internet traffic, which analysts view as an area of declining business.
“Their legacy products still have the highest gross margins,” said Chandan Sarkar, an analyst at Auriga USA LLC. “That area, unfortunately, is where their revenue has been going down the most.”
The company, based in Naperville, Ill., is aware of these concerns and is strategically realigning itself for growth. To get its foot in the mobile phone gateway sector, Tellabs purchased Silicon Valley start-up WiChorus for $165 million in December. Since the acquisition, WiChorus’s SmartCore, a 4G mobile technology, has been integrated into Tellabs’s product line.
“[The SmartCore] could be profitable because it has the highest margin of their growth products,” Sarkar said. “But there is a ton of competition from companies like Alcatel Lucent and Ericsson in that sector.”
Personnel changes are also afoot. Tellabs plans to slash 200 jobs in the next several quarters. The goal is to shift resources away from its traditional wireline business to its growing Ethernet and data products. The restructuring, however, will carry a price tag of $20 million in charges and as much as $11 million in cash costs. Despite the reduction, Tellabs expects to increase overall headcount in 2010.
On the research and development front, management has “applied more than 80 percent of … R&D spending to develop innovative mobile, optical and Internet Protocol products,” wrote Robert W. Pullen, president and CEO of Tellabs, in a letter to stockholders in March.
Another major concern among analysts is Tellabs’s reliance on a few customers for the bulk of its business. For instance, sales to Verizon Wireless Inc. and AT&T Inc. combined accounted for almost half of Tellabs’s consolidated revenue in 2009. A slight aberration in either company’s equipment spending could drastically affect Tellabs’s top line.
“The telecommunications industry has been recently affected by reduced capital spending by carriers,” stated Citigroup analyst Jim Suva in a research report. “Infrastructure improvements may be delayed or prevented depending on business conditions and consumer demand for these products.”
Competition is also intense in the telecommunications equipment space. The combined market share of the top three vendors (Nokia Siemens Networks, Alcatel-Lucent and L.M. Ericsson Telephone Co.) is more than 50 percent, while Tellabs, a mid-sized company, holds less than 5 percent.
In spite of these shortcomings, Tellabs had better-than-expected numbers in the fourth quarter. It earned $62 million, or 16 cents a share, up from the year-earlier $13 million, on revenue of $389 million. The profit included a tax benefit of $23.4 million, or 6 cents a share.
The main surprise, however, was the company’s improved overall gross margin, which increased 540 basis points to 43.6 percent from the year-earlier period. Management attributed the strong performance to improved profitability of its 7100 optical product line and increased sales of the 5500 Digital Cross-Connect, which still carries one of the highest profit margins.
In February Tellabs returned capital to shareholders by paying a new quarterly dividend of 2 cents per share. It also repurchased 3.4 million shares at a cost of $21.2 million in the fourth quarter, and plans to continue its share repurchase program during 2010.
“It’s based on our confidence that Tellabs will continue to generate ample cash from operations to invest in the growth of our business, repurchase shares and pay dividends,” Pullen said.
For 2010 Tellabs projected first-quarter revenue of $370 million, plus or minus 2 percent, slightly ahead of Wall Street’s estimate of $365 million. Striving to continue improving its gross margin, the company set a goal of 48.5 percent, also higher than the Street’s estimate. The company also projected full-year gross margin “in the mid-40s,” which caught the attention of Citigroup’s Suva.
“[It] implies material margin compression in the back half of the year driven largely by mix,” Suva stated in his note, referring to the fluctuating demand for the company’s products, some of which could yield lower profit margins.
The company’s stock currently trades at a premium, with a price-earnings ratio of 29 compared to the Standard & Poor’s 500 Stock Index price-earnings ratio of 22. For comparison, ADTRAN Inc., a similar sized competitor, has a price-earnings ratio of 24.
Since January, Tellabs’s stock has enjoyed an upward trend. On April 14, UBS analyst Nikos Theodosopoulos upgraded it from neutral to buy, which helped the stock reach the high of $8.53, sharply contrasting with its 52-week low of $4.47 almost a year ago to the day.
“Carriers faced with meaningful bandwidth constraints in mobility are unlikely to fulfill capacity requirements solely with next-gen offerings,” Theodosopoulos stated. “Having to also rely on some legacy technologies in 2010 is likely to positively impact Tellabs financial results.”
Tellabs plans to release its first quarter earnings on April 27.