Redback Acquisition Very Positive for Extreme (EXTR)
Posted on December 20, 2006
Last evening Ericsson announced an agreement to acquire Redback Networks (RBAK) for $2.1 billion in cash or about $25 per share. This allows us to lock in a 150%+ gain on our original Redback investment, the first pick we made on this site back in October 2005.
More importantly, though, are the repercussions that the Redback deal will have on the entire networking industry and specifically for our latest pick: Extreme Networks (EXTR). As regards to the industry, the Redback deal highlights a growing need among service providers to upgrade their networks to accommodate the huge growth in bandwidth demands, particularly for consumer downloads and in addition the increasing need to deliver that content to mobile devices.
As regards to Extreme:
While Redback and Extreme are focused on different product areas (i.e. Redback makes “edge” routers, while Extreme makes L3 switches) and have a somewhat different market focus (i.e. Redback is carrier-focused, while Extreme appears to be more enteprise-focused), the valuation afforded to Redback (8X EV/R) can and will be used to analyze others companies in the sector, such as Extreme. At less than 1X EV/revenue, EXTR appears dramatically undervalued.
Extreme’s discounted valuation of course reflects dissappointing recent growth and heavy competitive pressure. However, we believe these negative factors will be mitigated in the coming year as restructuring efforts begin to pay off. In addition, as regards to the Cisco risk, it is important to note that RBAK too faced intense competiion from Cisco, with Cisco controlling greater than 50% of the market in which RBAK competes. As such, it’s hard to argue for a substantial “Cisco competitive ” discount after the RBAK deal.
Overall, the valuation afforded to RBAK clearly shows the potential upside for EXTR should the company succeed in stabilizing revenue, returning to profitability, and communicating a solid plan for future growth. In any event, Extreme (EXTR) too is a likely acquisition candidate sooner rather than later. The possible suitor: Avaya (AV). Avaya is already Extreme’s most important channel partner and the company could easily swallow a company of EXTR’s size.
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