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Extreme Networks (EXTR): Way Oversold

Posted on August 3, 2007

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.

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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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