Monday, January 31, 2005

SBC buys AT&T; Ciena could suffer

Its official! SBC is buying T for $16B. SBC is buying T for its large business customer base, but wireline business has become a tough business with most companies having very difficult time in generating growth from this business. This acquisition should help stop the tide of declining wireline revenue but do not expect major turnaroud in wireline, consider this a stop-gap for few years. T purchase by SBC will have no affect on the wireless landscape. Expect VZ and BLS to start thinking about buying FON, MCI or Q. Like T, FON also has large business customer list and so does MCI. Buying FON makes the most sense for VZ. For one VZ can regain the #1 wireless subscriber throne that SBC/BLS took away from it by buying AT&T Wireless through Cingular. VZ has indicated that it wishes to make wireless larger portion of its revenues. Plus FON brings a well established IP based long-distance network as well. With NXTL already in process of buying FON, competitve bids could give a nice pop to stock.

On equipment provider side, the biggest negative affect from T acquisition by SBC is for CIEN which supplies T with Metro DWDM products but not to SBC which buys its Metro DWDM products from NT. T also buys long haul DWDM products from LU and that is also supplied to SBC by NT. CIEN also supplies T with Optical Switching capability but SBC uses ALA for that.

Consolidation as a whole could be positive for equipment providers over time as the profitability of carriers improves but in the short term consolidation is a distraction that equipment providers do not need their customers to have.

Sunday, January 30, 2005

Quality Names in Technology - Part 1

When I made the comment a few months back that semis are going to be in pain into earnings, I wasn't so sure about non-Semi companies having such difficult time but even non-semis have had a tough time. I pointed out late last year that tech was ahead of itself and street estimates were ahead of reality especially in semis. Even with the recent sell off, tech is still trading at significant premium(28X) to non-tech while its forecasted to grow less than 1% faster in 2005. But with the situation with Iraqi elections looking like a positive, expect market to trade higher in the near-term.

I won't try to talk about which companies had bad earnings. Let's try to find companies that reported strong quarters and have differentiated offering to make them winners over time. We are going to continue to focus on tech areas/companies that are growing faster than the market but are not selling at a huge premium. Quality deserves premium valuation but I am not going to play through the nose. The areas I would focuse on are IP related, security, offshore, digital consumer. We talked about some of these issues in my piece on what to expect this year.

Lets begin with IP related services which include JNPR and FFIV that reported earlier this month. Both companies had above expectations quarter, both companies are very tech-saavy and are ahead of competition in their core area of expertise and as you would expect are under constant competitive threat. JNPR had a strong quarter in routing and security turned around nicely as well. What makes JNPR special is that its technology is being deployed by all major carriers around the world and its adding security and most probably will offer (switching/ higher level services) . JNPR plays well in all the hot growth markets but that puts it on the radar of bigger competitors. CSCO has made JNPR its main target and their is no doubt that this battle will lead to some pricing pressure for both. Margins is where the story gets tough for JNPR, with 70% GM and 30% operating margins the operating leverage will be tough to grow but JNPR management is usually conservative. Given the guidance for next quarter, the incremental gross margin is basically nil. Revenue growth will be the major driver of EPS going forward. Even with all these issues, I believe JNPR can outperform the market given that revenues are expected to grow 48% in 2005 and stock trades at 38x (on EPS estimates that will surely move higher) and I would be a buyer.

FFIV is another company that has performed very well in a niche market, just like JNPR did in its early days. FFIV makes what is known as layer 4 to 7 appliances which add intelligence to the traffic flowing in corporate LANs and WANs. FFIV also makes security appliances but recent results for security were little weak. Overall the results were more than stellar revenues grew 20% sequentially. Reported revenues for December were same as what the street expected FFIV to achieve by' June 05, and guidance for March is equivalent to what the street expected FFIV to do in Dec 05 -- now that is serious outperformance. FFIV gross margins are also a stellar 77%, and operating margins are at 24%. The issue remains with the security products sales that failed to reach management's goal. Security remains one of the hottest markets and for now FFIV can grow rapidly even without Security but sooner or later management has to realign the sales force and the channel to also focus on Security products. FFIV is expected to grow its revenues 43% in 2005 and trades at 40x (not exactly a cheap valuation), so look to buy on pull backs to mid $30 level.

I look forward to hearing from investors regarding companies they feel have similar characteristics to the ones mentioned above.

Wednesday, January 12, 2005

Why street got AAPL estimates so wrong

Usually companies like to beat expectations by a penny or two even if they can do say four pennies, because they don't like uncertainty and they move shipments to next quarter for backup. AAPL on the other smacked one out of the ballpark and then some. AAPL beat EPS estimates by unheard of $0.29! Now what are the buy-siders paying for when the sell siders estimates are not even in the same time zone? AAPL reported $0.70 in earnings, did you know the street was looking for $0.60 next XMas and AAPL delivered better than that this Xmas.

The iPod brand has transformed itself into a eco-system and it's just very tough to get all the variables right when a product becomes a "economy" by itself. The iPod has been one of the best marketing blitz in AAPL history or for that matter in consumer technology and it does not matter how many channel checks you do, how closely you monitor the food-chain, it is just going to be very tough to get this cultural phenomena down to a number. So cut sell siders a break and watch for the next iPod-like product because this cycle will be repeated.

No I am not a sell sider who covers AAPL.

Tuesday, January 11, 2005

INTC keeps spending , but why?

Semi Cap companies, specifically AMAT, ASMI, WFR, NVLS, will have the largest spender continue to spend more and more to stay "competitive". INTC announced that it plans to spend $4.9 to $5.3B next year on capex and most of that on equipment. This is much better than most people were expecting, including yours truly, and will certainly light a fire under some of the semi cap names mentioned above. INTC also suggested that it expects capacity utilization to be higher next quarter which means more equipment will be needed as utilization moves higher, or so goes the argument. I still believe this is a tough industry since overall capex in 2005 spending will still be down around 10% even with the big bump by INTC as the number of companies willing and able to spend that kind of money continues to shrink.

Now here is my argument on why it makes little sense for INTC to keep spending this kind of money. I agree that it still makes tactical sense to have in-house fabs but for how long is the question. The Ghz race is over, PC cycle is gone to replacement-cycle . INTC, AMD and other major IDMs have to become consumer IC companies and consumer ICs are built cheap. Most of us consumers don't really need a 4GHz Pentium or dual core Opteron for that matter. We just need a high bandwidth connection with safe web-browser-like application (no not IE) and a 2GHz machine will be more than enough.

Semiconductors will be for consumer market where its about cost not necessarily raw-power. Selling to consumers requires marketing prowess not souped up clock speed. It's going to be about marketing the box, ask AAPL which has done a faboulous job selling the iPod to masses. Does the iPod have "PortalPlayer Inside" stickers on it? It doesn't matter to a consumer who is inside the iPod they want the iPod to be as cheap as possible and still perform well. So without the "speed-race" do INTC really need to build new cutting edge fabs? They can build them but I would worry about the ROI coming down dramatically on the fabs which will hurt the gross margin at INTC. Even with all this spending INTC revs grew 13.5% in 2004 where as the semi industry revs grew 28-30%. That is on top of the usual pricing pressure that comes naturally with playing in highly competitve consumer market. Spending large amounts does not necessarily mean revenue growth and with revenue growth slowing and spending increasing the overall equation will change and margins will shrink. But timing is everything and this will not play out in a quarter or two so until then let INTC keep pushing the Ghz and the dual-core mantra and lets hope the consumer buys it.

I would truely appreciate feedback on this from both professional and amateur investors .

Wednesday, January 05, 2005

The hits keep on coming- XLNX

XLNX lowered guidance for December quarter, that's the second time they have lowered guidance for Decemeber. I been wary of semis and this continues to support my view of weak end markets. For one thing XLNX's prior December guidance was little bit better than ALTR, so I do not expect ALTR to lower guidance. The inventory build at the semis will continue to be of concern for Q1 and beyond which is what I have been saying for a while. This also makes me little concern about wireless equipment providers like ERICY, NT and LU where most of the weakness is coming from for XLNX.

Monday, January 03, 2005

ISSI miss and semi implications

ISSI pre-announced after market close today. ISSI blamed "too much inventory" which led to pricing pressure for the miss. It's a 10% miss on top line, which is worrisome in itself but that's on top of the recent acquistion of Signia- I can't imagine how bad it would've been without that acquisition . Other DRAM suppliers will face more pain. I continue to think semis have tough time ahead especially the ones that have low or no technology differentiation and have selective shorts. This should have little to no implications for handsets and routers since they use SRAM mostly and ISSI blamed DRAM for the miss.

It’s a tough market- pick your stocks wisely

Welcome to the New Year; hope 2004 was a successful one for all. Here is a short summary of what I am thinking for this year and longer-term in tech. Some of the semis could have issues given limited growth potential as the largest consumption of semis- PC becomes a replacement market. As likes of WMT offer $400 laptop. Semiconductor growth will likely come from FTTP, GbE, HDTV/ATV, IPv6, 3G, VoIP, & advanced set-top boxes. But tough pricing (as inventories loom) and street estimates ahead of reality could cause trouble. Same with Semi Caps as end market is tough with number of customers shrinking (how many of us can afford a $4b fab?) and too many suppliers that are offering newer technology equipment at older technology prices- really that won’t fly for too long. Overall Software growth is slowing as well, with acquisitions becoming the growth play but small niche players having better luck growing. Service is where growth will be. Look for outsourcers to grow, SAY is hiring 30,000 employees- do you know any one else doing that kind of hiring? More and more outsourcing firms will focus on moving into higher level/system level work. Hardware is commoditized but software value will keep the boat afloat, count on SUNW to get into other verticals using their processing prowess. Storage is doing ok due to some underinvestment, Sarbanes-Oxley and data growth but pricing needs to be watched. Telco equipment will have very focused growth especially in IP/MPLS, FTTx, 2.5G/3G, next-gen SONET, Metro Ethernet. Handsets will grow but tough to make money unless you are QCOM. Infrastructure suppliers will become more service driven than hardware driven. Look for NT, ALA, LU to basically give away equipment to sell service contracts as Chinese move into equipment game and partner with these “old guards” for mutual benefits. CSCO acquisitions last year focused on buying software intelligence because hardware will become commoditized and differentiation will be from services and/or software intelligence. Overall tech will be tough so pick your stocks wisely.