Description

This is a technology idea with a growthy flavor. If you believe that value and growth are just two sides of the same coin, then you may find this idea attractive. If you believe that value is exclusively defined by cash flow and hard assets, then this idea will hold little appeal.



Redback Networks is a manufacturer of leading edge telecommunications equipment used by carriers around the world for enabling broadband, or high speed internet, access. The company went public in mid-1999, a time when many carriers were just beginning to accelerate their deployment of broadband equipment. Their solution, known as SMS, found rapid acceptance and revenues exploded, rising tenfold to $115 million by the fourth quarter of 2000.

But by then, however, a broad downturn in the telecommunications market had begun and the company’s fortunes began to ebb. As the downturn gave way to, in the words of one prominent industry executive, a “nuclear winter,” the company was forced to restructure, ultimately filing for a prepackaged bankruptcy in November 2003.

In January 2004 the company emerged from bankruptcy, with its product line, customer relationships and intellectual property intact. While the previous equity holders were essentially wiped out, post bankruptcy equity holders own what is essentially the same company, but at a fraction of the valuation, and having the advantage of a debt free balance sheet and far leaner cost structure.

While the company’s original fortunes rested upon their SMS product line, in recent quarters this has given way to a successor line, known as the SmartEdge. The SmartEdge is a very strong product offering for enabling voice, video and data services over a common architecture. These so-called “triple play” services are a current area of focus for almost every important carrier, and Redback’s platform has won many important contracts in competition with larger and better capitalized competitors.

The company is currently in the midst of a slightly awkward transition, as legacy product revenues decline, but next generation product revenues are not quite sufficient to grow the company. As can be seen below, the company’s lackluster top line growth belies considerable momentum for its SmartEdge product.


Product Revenues Q1:04 Q2:04 Q3:04 Q4:04 Q1:05 Q2:05

SMS 15,812 17,238 4,643 9,400 9,316 10,300
SmartEdge 9,668 8,570 10,207 16,400 18,984 18,300
Total 25,480 25,808 14,850 25,800 28,300 28,600


Indeed, the company’s SmartEdge revenues have more than doubled year-on-year, gaining significant traction with customers large and small. Recently, this platform has won a number of important contracts that all but guarantee an extended period of very robust revenue growth. For example,

• in February, the company won a particularly large and influential contract from Bellsouth that could contribute in excess of $40 million revenues annually for several years beginning in 2006. Recent comments by Bellsouth indicate that an aggressive and high profile broadband deployment is in the offing.

• in May, Redback won the broadband aggregation portion of British Telecom’s massive $20 billion network upgrade, the most visible and important network upgrade today. Certain aspects of the deployment plan remain inchoate, but annual revenues here should be at least $20mm for the next several years. Under certain conditions, revenue potential may even approach that of the Bellsouth contract.

• most recently, the company won a contract with China Netcom, that country’s largest wireline network, to roll out their triple play infrastructure.

Other important SmartEdge customers include the national phone companies of Korea and Taiwan, as well as a long list of mid-tier carriers. Important potential customers include SBC, which has widely deployed the company’s SMS line. In the coming quarters, I expect SmartEdge revenue growth to far overshadow declining SMS revenues, leading to substantial top line growth.

The rise of the internet has forced the global telecommunications industry to the cusp of profound change. Now, a number of important financial, competitive and regulatory dynamics are catalyzing an important investment cycle that should last well beyond the end of this decade. Redback has a strong product offering and should see substantial opportunities above and beyond what it has already captured.

Catalyst

H2:05 and 2006 revenue growth will be very strong.