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Archive for August, 2007

Housing Hits Zilog (ZILG), But Future Growth Opportunities Abound

August 6th, 2007 by Yehuda Fruchter   |   No Comments

Currently there is alot of discussion about whether the current Wall Street credit crunch, will spread to the “real” economy. Generally, Wall Street’s paper economy is quite divorced from any reality, and hence major downturns in Markets do not cause significant ripples to other unrelated “real” sectors of the economy. However, the current sell-off may very well be an exception.

Case in point: Zilog (ZILG), a fabless semiconductor company, that at first glance would seem quite immune from happenings in the credit markets. Last week, however, the company reported a significant revenue decline both year-over-year and quarter-to-quarter. The reason given: a slowdown in housing.

As CEO, Darin Billerbeck, explained:

“The sales decline for the quarter was disappointing and reflected a generally soft demand overall. The North American home security market was slow due to the decline in new housing starts which impacted the end consumption of certain of our legacy products.”

The stock has taken a dive since the earnings report and has now fallen nearly 40% from its high reached back in June. Of course, the key question, now is what to do with ZILG after this decline? The answer, as always, is to stay positive and focus on the fundamentals. As we have stated in past posts, small cap stocks are simply getting mauled in the current market downturn. The key thing is recognize that the selling is primarily driven by overleveraged hedge funds and other panicky investors. The declines have little to do with the underlying financial health and potential of these companies.

In the case of ZILG, despite the sales decline, the company still managed to generate some cash during the quarter and ended the quarter with nearly $20 million in cash and no debt. Hence, the company has absolutely zero financial risk at this time, and therefore can be bought on dips.

Furthermore, the sales dissappointment was entirely related to the company’s legacy product line, which does not represent the future of the company. Importantly, the company’s newer embedded flash 8-bit products were up sequentially 19 percent and 52 percent year over year. In addition, the company is making excellent progress in bringing to market its 32-bit ARM based products for the secured transaction market. Both the Flash and ARM-based products represent substantial growth opportunties for ZILG over the next few years. Unfortunately, these newer product lines are still only a small portion of ZILG’s total revenue and hence their financial impact is not yet felt in the company as a whole.

However, we still remain confident that the company has the right management team in place, and the necessary financial strength, to generate significant revenue growth from the new Flash and ARM product lines in the coming years. As we’ve mentioned in the past, new CEO,Mr. Billerback was a former co-head of Intel’s $2 billion Flash division and we remain confident that he has the skill set and connections to greatly expand ZILG’s business in its new target markets.

Moreover, the valuation of the company does not in the least bit reflect the potential of these growth opportunities. At current prices, ZILG’s Enterprise Value is a miniscule $43 million, which when measured against our low-end base scenario of $60 million in annual revenue, implies an EV/Sales ratio of 0.7X. On a more normalized revenue run rate for ZILG of $80 million a year, this would translate into a ludicrous 0.5X EV/Sales. As such, we still expect that as the company’s Flash and ARM products ramp up in 2008, the stock’s valuation could jump significantly, as investors assign a more normalized valuation to the company in line with industry comps.

Please Note: We hold a position in ZILG. All ideas, opinions, and/or forecasts, expressed or implied herein, are for informational purposes only and should not be construed as a recommendation to invest, trade, and/or speculate in the markets. Any investments, trades, and/or speculations made in light of the ideas, opinions, and/or forecasts, expressed or implied herein, are committed at your own risk, financial or otherwise.

Extreme Networks (EXTR): Way Oversold

August 3rd, 2007 by Yehuda Fruchter   |   2 Comments

Earlier this week, Extreme Networks (EXTR), reported earnings that missed analysts expectations. The miss was primarily caused by higher discounts and commissions for the company’s fiscal year end, rather than any indication of slackening customer demand. In fact, the report demonstrated strong demand for Extreme’s new products, and a clear indication of the coming financial benefits from the company’s restructuring efforts.

The stock, not unexpectedly, has sold off dramatically since the report, as have many other technology stocks that miss or, even meet, analysts estimates. As you may have noticed, the current environment is simply horrendous for small cap stocks, so we’re not so sure one needs to try to figure out a rational explanation for the current slide.

With $215 million in cash, $0 debt, a base sales level of about $340 million, and an Enterprise Value of a mere $220 million (EV/Sales of 0.65), the selling pressure on the stock is clearly overdone. EXTR is not going away anytime soon, and the company has ample growth opportunities given the growth in bandwith and overall demand for switching solutions. Quite simply, the stock is going down, because it’s going down.

In the end, we think investors need to wait for at least two more quarters with EXTR to render judgement. Right now, assuming you are diversified, there is absolutely no reason for panic with these shares given the pristine balance sheet and large base business. Yes, the company’s not growing much, if at all, but, since the valuation is so depressed relative to larger competitors, like JNPR or FDRY, we believe EXTR will be sold to a larger competitor, if current management does not manage to reignite growth. This significantly limits downside risk in the stock.

In sum, to date, we’ve admittingly been completely wrong on this stock, but we still think patience will prevail. If we could take one lesson away from this current bad pick, it might be to stay away from turnaround technology stocks with too many Wall Street analysts. In such instances, analysts routinely have terrible forcasting models, which creates selling pressure when the companies fail to meet the expectations of these faulty estimates. Turnarounds, like EXTR, take time, and that’s the last thing most funds have, especially in a bad market.

Please Note: We first recommended Extreme Networks (EXTR) at $4.22, and still hold a position in the stock. All ideas, opinions, and/or forecasts, expressed or implied herein, are for informational purposes only and should not be construed as a recommendation to invest, trade, and/or speculate in the markets. Any investments, trades, and/or speculations made in light of the ideas, opinions, and/or forecasts, expressed or implied herein, are committed at your own risk, financial or otherwise.

T-3 Energy (TTES) Reports Results Ahead of Expectations

August 1st, 2007 by Yehuda Fruchter   |   No Comments

A day ago, T-3 Energy (TTES – first recommended at $12.13), reported financial results which handily beat Wall Street estimates. The company’s bottom-line jumped 50% year-over-year to $0.60 per share, on a 36% increase in revenue.

These results beat the high-end estimate from Bear, Stearns of $0.55 per share. For the full 2007 year, Bear now expects TTES to earn $2.35 per share. The analyst over at Pritchard Capital has the company earning $2.40 per share in 2007.

Interestingly, despite the continued strong results from TTES and the company’s solid growth opportunities, the stock still trades at a discount to its peer group. As we have noted in the past, this discount is probably related to the fact the company has only recently become attractive to institutions following a secondary back in April which shed the huge ownership position which First Reserve Fund had in TTES. As such, it is still taking some time for the company to market itself to Wall Street.

Nevertheless, the stock has performed very well this year, and is up about 45% since we reiterated a buy on the stock in April. Despite the solid gains, we still recommend holding onto the shares, as we think that with time, assuming continued positive earnings suprises, the stock will trade at a premium to its peers, given the company’s higher growth rate and more substantial expansion opportunities.
The comments from the Pritchard analyst sums up the situation pretty well:

“With a $500 million universal shelf, an un-drawn credit facility and a debt free balance sheet, TTES has the ability to fund substantially higher growth than we are assuming. We believe that a $6/share number is achievable long term if the company is successful in penetrating the wellhead market with the same success it has done in the BOP business. Acquisition growth could make that estimate low as well. “

Disclaimer: We own shares in TTES. This site may include market analysis and we may own shares in the stocks mentioned in our reports. All ideas, opinions, and/or forecasts, expressed or implied herein, are for informational purposes only and should not be construed as a recommendation to invest, trade, and/or speculate in the markets. Any investments, trades, and/or speculations made in light of the ideas, opinions, and/or forecasts, expressed or implied herein, are committed at your own risk, financial or otherwise.