Netopia NTPA.PK
March 21, 2005 - 1:44pm EST by
scrooge833
2005 2006
Price: 3.20 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 77 P/FCF
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 0 TEV/EBIT

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Description

I think Netopia is trading at under 7 x 2006 EPS, 5 X 2006 EBIT with a free option on triple play broadband that could easily make this a three bagger.

Netopia, is essentially the telcos’ R&D partner for broadband solutions to the home. There is so much to not like about a business model that is in a competitive, dynamic, unpredictable, technology field. Moreover, 75% of its revenues depend on the telcos. However, Netopia’s technology is well-respected and its products are participating in all the high-growth areas of technology with a visible 3 year growth trajectory. Furthermore, its two new software products have the potential to be recurring and sticky. I believe at today’s price, Netopia is trading at 7 times 2006 EPS estimates, and you get 2 “free options”- one on the triple play fiber to the home projects being launched by the telcos such as SBC, Bellsouth and the major telco players in Europe. The other option is on growth above my conservative estimates of its 2 software products (parental controls and wi-fi starter kits) and also, AMD’s use of Netopia’s technology for its Personal Internet communicator.

Netopia has two business segments: its R&D department makes and sells broadband with/without Wi-Fi routers, gateways. They use ADSL, ADSL+, VDSL. Netopia’s other business segment is software : they make the Timbuktu (a favorite among Mac Users), ECare and their newest products (the free option I referred to in the above paragraph) are the Parental Controls and Wi-Fi Hot Spot starter kits, that allow cafes and other business venues to provide secure, family-friendly Wi-Fi access to customers. You don’t see their products in Compusa or Best Buy because unlike Linksys, or D-Link, their customers are BellSouth, SBC, Swiss Telecom, EIRCom (Ireland’s biggest telecom), Vodacom, Earthlink, Covad, Belgacom (Belgium). If you are a small business that is serviced by BellSouth and you want to get a DSL service, BellSouth will give you the Netopia Gateway.

What makes Netopia’s broadband hardware products tick is their Wi-Fi 3dReach technology (which is a firmware/software solution) which surpasses any of the other vendors in terms of reception, etc. (See the independent lab test results in http://www.netopia.com/3DReach/News_IQ_Labs_Report.pdf/). This is important because less customer complaints mean less headaches. This is a successful selling point to the telcos.

Netopia’s primary competitor is Westell. Westell provides the gateways for Verizon, although there are some routers that Netopia does supply to Verizon.

For the next three years, I don’t see any of Netopia’s products, with the exception of their software business, (supplying yellow pages information to the telcos – approximately recurring 8 million every year, and Timbuktu and other Apple cult products which is another 4 million a year), that is not participating in a growth area that has CAGR of at least 25% each.

Strong Balance Sheet.
Zero debt. Market cap 77 Million. Cash of 23.5 Million. Current Ratio is 3.26.


Growth areas of Netopia’s products.

Trend 1. DSL adoption in the U.S. will grow at an estimated 30% per year for the next 2 years at least. Broadband penetration at 75% is when it starts to slow down. Currently, the U.S. is at a broadband penetration rate of about 45%. In addition, people will upgrade from the 256k speed to the 3 Megabit per second speed. For year ending 2005, Bellsouth wants net adds from 2.1 Million to 2.7 Million, a 30% increase. SBC grew is net DSL adds by 27% for the year 2004. In some parts of western Europe, the growth will be faster for 2005. EIRCOM plans to grow from 114,000 to 500,000 DSL users in three years (a 30% compounded growth rate) Switzerland which has a much higher penetration rate, will grow maybe in the 20% range. Net additions are a lower estimate of the actual devices Netopia will sell because if one were to upgrade a gateway, it will not be considered a net addition. Netopia’s broadband routers and gateways are being used by Bellsouth, SBC, Swisscom, EIRCom, Covad, Earthlink, and more. About $87 million (or 85%) of their revenues in 2004 come from the sale of these routers. With the estimated 25% growth for at least the next two years, I estimate Netopia’s revenues from this segment is expected to grow about 10% after forecasting a 15% ASP decline. (30% growth in unit volumes multiplied by 15% decline in ASPs). By comparison, volume growth in 2004 was about 47% and ASP decline was about 15%. (Westell, a competitor said in the conference call that they see maximum ASP decline to be 20% in 2005) So based on 2004 numbers, and projecting 30% growth (backed by Bellsouth,SBC,EIRCOM’s estimates of unit growth) in unit volumes and 15% ASP decline, I project 10% growth in 2005 and 2006, I arrive at 2006 Sales estimate of 105 Million.

Trend 2. Wi-fi hotspots will grow at a CAGR of 50% for the next five years, according to Gartner group. There are 2 million cafes and venues in the U.S. The proliferation of centrino powered notebooks and public wi-fi access at airports, convention centers, hotels is driving the push to have wi-fi access in these cafes and venues. The ROI is not clear. Do cafes charge for the access or do they give it free? Schlotsky’s (the deli franhise) saw their business grow by offering free internet access. Starbucks partnered with T-Mobile and saw their business grow. Netopia launched a hotspot in a box solution back in July 2004. In October of 2004, Netopia partnered with Bellsouth to offer these wi-fi hotspot solution starter kits to restaurants and small businesses. For a one-time $200 set-up fee, and a monthly 50$ fee that the venue pays Netopia, the venue gets to manage and charge internet access via prepaid cards (which is accepted more by the public than credit cards), customize the splash screen, receive ad revenues on the splash screen, offer family-friendly atmosphere, etc. This would be a high-gross margin (90% range) recurring revenue stream. If Netopia gets 1% (or 200,000) of these 2 Million locations, then it will have an annual revenue run rate of 10 Million starting in 2006. SBC is expected to make its decision in late summer on whether to proceed with this project or not. Related to this, Netopia has made the following announcements:
2/14 Netopia sings Deal with Sysco to deliver Hot Spot products to Sysco’s 9000+ customers.
3/16 Netopia Wi-Fi Gateways Couple with Verifone Payment Solutions
3/15 Payment Processing Direct selects Netopia and MegaPath

Useful links:
http://www.pcworld.com/news/article/0,aid,111418,00.asp
http://www.netopia.com/products/pdf/PL_HS_WP.pdf

Trend 3. Finally, the “triple play” fiber to the home projects being launched by SBC, BellSouth, Verizon and all the others. All the telcos would like to bring fiber to the home so they can play video over ADSL. This is to compete with Comcast and the other cable cos. Swisscom for example is using Microsoft’s IPTV product and Netopia’s gateway to deliver video over ADSL in a trial. SBC plans to wire 18 million homes in three years. Different solutions are being pursed by different telcos. However, it is clear that inside the home, a gateway would be needed. Netopia is in the short list of potential winners in the RFP’s for all of this fiber to the home, or FTTP, or fiber to the prem projects. The winner will most likely be announced sometime in summer (June to August) of 2005. Simply using a $20 per home gross profit margin (20% gross margins on a $100 product) means a BellSouth deal would be about $360 Million contributionntpa7 to Netopia. This is over 4 x its annual revenue. Of course, the winner of this RFP is uncertain, but there are at least three telco providers that Netopia is in the short list of vendors. Because of their head start in deployments in Europe, I believe Netopia has a good chance of winning proposals in this space. Related to this, Netopia made an announcement on 2/28/2005 – “Netopia Enables Triple Play Services with Breakthrough VGx Technology”



The high margin software business

Timbuktu, Ecare, customized web sites, yellow pages. This has been a stable 12-15M yearly revenue stream for Netopia.


Furthermore, Netopia has a parental controls service (which resides in the gateway) that is more secure than software solutions. Parents can limit the buddy list in AOL Instant messenger, Email, web site access, etc. As proof of the uniqueness of their product, Linksys (also a router manufacturer who sells mostly to consumers and is owned by Cisco) has decided to incorporate Netopia’s parental controls in their hotselling WRT54G router product. Because of foot print limitations, Linksys did not incorporate parental control in their lower-priced product but there is a possibility that it will be incorporated in the future. With 100 million homes in the U.S. that are broadband capable. Assuming 1% were to use the parental controls and at 40$ per year, that would be another 40 million annual recurring revenues. In Netopia’s last CC, they said that 40% who tried the 1 month, signed up for the service. Linksys shipped over 1 million routers last year. If you include Netopia’s partnerships with other telcos, (like EIRCOM), their distribution network is even more. So let’s assume 500,000 homes start using this parental controls software. This is like an anti-virus business model. You make money on yearly subscriptions to access the growing library of approved web url’s and filters. Netopia’s strategy is to partner with telcos or Linksys (owned by Cisco) to minimize expenses, and the headaches (billing, support, installation, customer inertia). My estimate of 20 Million is based on 500,000 homes at $40 per year by 2006. This is not unlikely given that they are basically bundling Linkysys routers with their parental software CDs, as well as the routers that come to homes that order DSL, ADSL2, etc with the telcos. In the last conference call, the CEO said they are seeing 40% conversion rates for people who try the software and later purchased the subscription. 500,000 homes is simply 0.5% of 100 Million households in the U.S. As of 2004, about 50% of households (50 million) have broadband access. It is estimated that by 2007, 70+% of households in the U.S. will have broadband. And I don’t include countries like Ireland (EIRCOM) which are also selling Netopia’s parental software.


So adding up our estimates
2006
12 Million from their yellow pages recurring software biz and Apple’s cult software products
+ 105 Million revenus from sale of ADSL,ADSL+,VDSL,Wi-fi broadband hardware routers, gateways. (85 million * 1.10 * 1.10) (Conservative estimate of gross margin of 20% versus 2004 Gross Margin of 24%)
+ 10 Million from Wi-fi Hotspot (90% gross margin)
+ 20 Million from Parental Controls (90% gross margin)
137 Million Revenues for 2006.
Gross Profit of 37 million (software) + 20 million (equipment) = 57 M
SG&A of 28M (Historically, SG&A on Equipment sales is 26%, SG&A on Sofware is much lower)
R&D of 17M (Historical figure. Should actually be lower after lay-offs)

About 12 million dollars EBIT. Tax rate is zero because they have NOLs in the 125 million range. So, EPS would be in the 0.46 to 0.48 cent range depending on what the shares outstanding will be. That is about 6.6 x 2006 EPS Current Enterpise value is $53M

My estimates would be in line with the analyst expectations of Needham and Kaufman Brothers.

Viewed differently, if you look at only the software business, you are buying at about 1 times recurring software revenue, and paying zero for their broadband equipment business.

In my analysis, I am not yet incorporating the Triple Play product potential revenues. As I said above, it is not inconceivable that they get a 360 Million gross profits on the triple play within a three year period. The current market cap of Netopia is 77 Million, and it has 24 Million cash, and zero debt.

In short, this stock is cheap, trading at 6.6 * 2006 EPS numbers, 5 x EV/Estimated EBIT for 2006, 0.50 x EV/2004 Sales. And if they win in the triple play product, this stock could be a huge home run. Granted, this is a technology stock and the main question is what do you do with a stock whose 10 year future will never be as predictable as a non-tech company, but you can buy at a p/e of under 7, with a free option that could make the stock move up to 3x its market cap over the next three years? Essentially an R&D for the telcos, this business does not require high capital expenditures and you are buying the output of its R*D and intellectual capital.

Another thing I briefly mentioned is AMD’s use of Netopia’s technology for its Personal Internet communicator. See the news release on 2/15. AMD’s product is a low-cost consumer device that is aimed at users in developing countries like Russia, Mexico, India, Brazil. Again, I did not include this in my estimates.

What could explain the stock price drop?

It’s a little case like the boy who cried wolf. After a while, you don’t listen to them anymore. Going back to April of 2004, Netopia has had nothing but a string of bad news. They missed analyst’s estimates in April of 2004. In July, 2004, they missed earnings because of price increases in flash and DRAM. Then they had to restate financials on a questionable transaction amounting to 1.5 million. (To put in perspective, Netopia’s sales is in the 100+ million range). KPMG resigned. They replaced KPMG with the auditors who were in charged of their audit probe. They had to delay their filings twice. The stock traded in the OTCBB then it moved to the pink sheets. And On Feb. 9, 2005, they announced results that again missed analysts’ estimates. Things keep getting delayed. But if you believe that if “Something is not gonna last forever, then it will stop”, then you must believe these delays will not last forever either.

However, they have to be credited for getting rid of their CFO and that they ordered a complete investigation, costing them 3.5 million $, for a questionable amount that is as little as 1.5 Million. At least, they seem to be on the right side of corporate governance. They never provide guidance. Their CEO has a good resume and seems very capable and has options to buy 1 million shares of Netopia at much higher strike prices.

Catalyst

Nasdaq small cap or NMS within 30-45 days from their 10-Q filing which was 2/9/05.
Late Summer - Announcement of BellSouth’s decision to use Netopia for its Wi-Fi café/retailer/venue initiative.
Late Summer - Announcement of winner of triple play proposals(Fiber to the home buildouts) by SBC or Bellsouth or other Telcos
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