Extreme Networks (EXTR): Moving in the Right Direction
Posted on January 28, 2007
Late last week, Extreme Networks (EXTR) reported quarterly results, which continue to support our investment thesis, that EXTR has limited downside risk at current prices, and substantial upside potential, assuming new management continues to drive positive change at the company.
The most important positives from the quarterly results were:
Balance Sheet Remains Pristine Limiting Downside Risk
During the quarter, Extreme Networks (EXTR), paid down all of its debt and exited the quarter with nearly $205 million in cash. This large cash cushion implies that there is little to no financial risk at the company and investors can remain comfortable holding the shares as the turnaround progresses.
Book-To-Bill Signals Healthy Business Growth
During the conference call, management of Extreme highlighted that the company’s Book-to-Bill ratio was greater than one, due to higher than anticipated demand for the new Summit X450 stackable switch. The book-to-bill ration is the ratio of business “booked” (orders taken) to business “billed” (products shipped and bills sent). A book-to-bill ratio higher than one (1) is encouraging.
On the negative side:
US Sales Remain Disappointing
The most glaring negative of the quarter was the continued weakness in the company’s US sales. Management indicated, though, that they continue to restructure and re-train the US salesforce, and they expect to see positive results from these efforts in the coming quarters.
Options Investigation Still An Issue
In addition, Extreme, like many other high-tech companies, is still undergoing investigation related to past option practices. While we don’t view this investigation as important from a business perspective, it’s probably the case that this may limit demand for the shares in the interim, as some investors will shy away from the stock until the company files updated financials.
Valuation Remains Depressed and Already Reflects All the Negatives
Despite evidence of improving results, Extreme’s stock price remains depressed as evidenced by an Enterprise Value (EV) to Revenue ratio of less than 1, with competitors such as Foundry Networks (FDRY) sporting EV/Sales ratios of 3X+. The discounted valuation reflects years of underperformance by the company from both a business and shareholder perspective.
Underperformance Indicates Substantial Upside Opportunity
However, despite past underperformance, the company appears to be undergoing significant changes under a new management team and as current results suggest there is ample room for continued upside surprises in the year ahead.
In general, in these types of turnaround situations, most analysts on Wall Street prefer to wait for several quarters of improving results until they become more positive on the company. In fact, out of the eight analyst reports we have read on EXTR, only two analysts are positive on the company, and only moderately so. Clearly, in the case of EXTR, the negatives are already well understood and priced in by the Market.
Our view, howver, is that since EXTR’s share price pretty much already reflects worst case scenarios, and there is ample evidence to suggest that substantial positive business changes will be coming in the next year, you have no need to wait here. In sum, at current prices, there is little to lose and much to gain, the perfect investment combination.
We would note, in the case of EXTR, that if the company continues to report improving financial results and US sales begin picking up, there is absolutely no reason why the company should trade at a substantial valuation discount to its peers. In fact, a valuation more in line with industry comps, would suggest a potential target price of $8 to $10 in the coming year, if results continue to improve.
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.
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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.
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