Description

Sycamore Networks (SCMR) is a cash-heavy technology company that trades at a price below the net cash and securities on the balance sheet and also below current assets less total liabilities (assigning a zero value to fixed assets and intellectual property).  Neo628 did a great job of writing the company up on VIC in 2004, though since then a few things have changed (including a substantial return of cash to shareholders and a 1 for 10 reverse stock split, both in December 2009) so I thought it was a good time to revisit the idea. 

Sycamore is a telecommunications equipment company - a provider of "Intelligent Bandwidth Management solutions," i.e., optical switches and multiservice cross-connect and access products for fixed line and mobile network operators worldwide.  Customers include Verizon, Sprint Nextel, Vodafone, NTT, Korea Telecom, China Netcom, and the US Dept of Defense.  Verizon and Sprint Nextel accounted for 19% and 12% of the FYE ended July31, 2009. 

SCMR competes with telecoms equipment  heavyweights such as Alcatel-Lucent, Ciena, Cisco, Sony Ericsson, Fujitsu, Huawei Techologies, Nortel, Nokia Siemens, and Tellabs.   Sycamore's business has suffered dramatically from the economic downturn.  Sales dropped to $67.4mm in FYE 31July09 from $115.5mm in FYE 31Jul08 (and from $156.0mm in FYE 31Jul07).  But SCMR has been cutting its expense base dramatically in response in order to minimize cash burn.  Cash (used) from operating activities + CapEx in FYE 09 was a mere negative $17mm.  At the end of Q110 (ended 24Oct09) the company had $920.3mm of cash (pre-Dec09 cash distribution), so this illustrates the minimal rate of the cash burn relative to the amount of cash on the balance sheet.

The company is always looking to minimize expenses.  Management has very modest compensation and the company has been continually reducing its headcount.  At the end of Q309 the company announced a 30% workforce reduction plan to take place over the next several quarters, to get to 300 workers.   The result of this was evident at the end of Q110 when headcount was 312 (compared to 479 a year earlier), further reducing the cash burn rate.

Whether Sycamore's equipment business can reach a critical mass to operate at a cash flow positive rate is not yet known, but even assigning a zero value to this business still leaves the company trading at a discount to the remaining net assets.

At the end of Q110 (quarter ended 24Oct09) SCMR had $920mm of cash and investments, $949.6mm of current assets, $22.4mm of current liabilities, and $29.2mm of total liabilities.  The company has no debt.  So current assets less total liabilities was $920.4mm.  On 16Dec09 SCMR paid out a special cash distribution of $1 per pre-split share, and on 22Dec09, SCMR completed a 1 for 10 reverse stock split.  The result was the company had proforma ("pf") cash and investments of $636mm, pf current assets of $665.3mm, pf current liabilities of $22.4mm, pf total liabilities of $29.2mm, and pf current assets less total liabilities of $636.1mm.  Post reverse-split share count was 28.432mm. 

Current equity market cap is $566.1mm and total enterprise value is negative (-) $69.9mm.   

In the table below I outline the data in the Q110 10-Q proforma for the special cash distribution and the reverse stock split.  I also use the valuation metrics of competitor Ciena Labs to come up with a conservative value for SCMR's telecoms equipment business.  CIEN also operates a negative-cash burn business, and CIEN trades at 1.6x revenues.   I haircut that down to 1x LTM revenues to come up with a $67.5mm value for SCMR's telecoms equipment business.

24Oct09 ProForma                                           $mm                      Per Share            Share Price as % of

Cash & Investments                                       636.0                     22.37                     89.0%

Current Assets                                               665.3                     23.40

Current Liabilities                                            22.4                          .79

Total Liabilities                                               29.2                        1.03

Current Assets - Total Liabilities                      636.1                     22.40                     89.0%

Telecoms Business @1x LTM sales                    67.5                        2.38

Curr Assets-Tot Liabs + Tel Bus.                     703.6                     24.75                     80.4%

The table highlights that SCMR trades at an appreciable discount to cash, current assets minus total liabilities and current assets minus total liabilities plus value of the telecoms business.  With the shrinking cash burn rate thanks to headcount reductions and a close eye on expenses, the discounts shouldn't erode much.

Third Avenue Management has been a long time investor in SCMR, and increased its stake in the Fall of 2009 by 5,017,952 (pre-split) shares to 45,447,772(pre-split) shares, or 16% of the company, according to Third Avenue's Q409 shareholder letter and Third Avenue's 13-F for of 9/30/09.  Divide by 10 to get post split shares.

Insiders are large holders of the company's shares.  The co-founder and chairman, Gururaj Deshpande, owns 45,712,807 (pre-split) shares, and CEO Daniel E. Smith owns 42,653,857 (pre-split) shares, for 30.1% between the two of them.   All directors and officers own 33.4% of the company, so they have a highly vested interest in doing what's best for shareholders.  A trust controlled by Deshpande's wife owns a further 6.3% of SCMR shares (Deshpande disclaims beneficial ownership of these trust shares).  Both Deshpande and Smith were at Cascade Communications; Deshpande co-founded Cascade and Smith was CEO/President.  They sold Cascade to Ascend Communications  in 1997 for $2.8 billion, so they have a track record of value-maximization. 

With D&O owning so much of the company, I'm comfortable they'll tread very carefully in terms of deploying that cash.  The fact that they returned a big chunk of the cash to shareholders shows they're not averse to returning it if no better uses can be found for it. 

Dan Smith said on the Q309 conference call "we continue to look at a number of strategic opportunities and those run the gamut from, we have efforts underway in terms of organic kinds of development.  Secondly looking at things we can inter into with respect to M&A activity to expand the served available market into adjacent space, we continue to look at those and there may be opportunities as time unfolds.  And I think you appreciate the management team owns a lot of the company and we see think differently than a lot of companies do with respect to cash and shareholders' assets and we continue to look very carefully at what's the best way to provide for shareholder returns with those assets."

In short, SCMR is trading at an appreciable discount to the value of cash, to the value of net assets (excluding fixed assets/IP), and to the value of total net assets (including fixed assets/IP at 1.0x sales).  D&O with 33.4% ownership of the company and modest compensation, should not do anything value destructive with the cash.  So the cash per share/net asset per share figures should be a worse case scenario since anything a 1/3 owner of the company would do should be value additive.

Catalyst

Value additive transactions, if any can be found, otherwise I'd expect more cash to be returned to shareholders over time.