It must hurt to be part of Tellabs (NASDAQ:TLAB) management. You announce a $225 million share buyback (22.5% of shares outstanding!), and the market does not care. You scream at the top of your voice that business is great but your stock is undervalued (P/B at 0.83), the market does not care. You proclaim the appointment of a company veteran as CEO, the market does not care. You announce a special cash dividend worth 40% of your stock's closing price, and the market does not care. It thinks a dollar in hard cash from Tellabs' pockets ain't worth a buck. Even after 2 major announcements (22.5% share buyback and a special dividend worth 40% of pre-announcement stock price), Mr. Market gave TLAB barely a $0.50 lift. Arguably, arbitrageurs can invest in the stock now, collect the $1 dividend and sell immediately post-dividend date, assuming the drop will be only the same $0.50 that the market has given TLAB after the announcements, so that the situation returns to status quo ante. Of course, the market may not follow this course, but it would be bizarre for the TLAB stock to drop more than $1 ex-dividend. If it drops by less than $1 ex-dividend, arbitrageurs gain, but if the drop is more, then they have been suckered by Mr. Market. Anyway, what more can a management team do to get some respect from the market? All they can do is suck it up and continue to deliver great business results.
Tellabs is in an unfortunate position as far as the stock is concerned. Despite $1.14 billion in cash and short-term investments, the market has given it a valuation of barely $1.24 billion. This company provides solutions to about 80% of the world's top telecom service providers, but according to Mr. Market, it is worth only $100 million ex-cash, that is, about $0.27 a share. Let's think about that for a minute. A company where over 2,600 people work, contributing to $1.29 billion sales in 2011, well-diversified (with over half of its sales from outside North America), with a 2011 GAAP earnings of $0.52 per share, and with zero long-term debt, is worth only $0.27 a share? So, Mr. Market gives it an ex-cash trailing P/E ratio of 0.5! The market must believe Tellabs is going to fall off the planet to give its core business this kind of valuation.
I realize that Tellabs may face significant customer pressure as a supplier to the major telecom giants of the world but the core services it provides - mobile backhaul services, improving network efficiency and business solutions - is certainly valuable for customers across the world to continue relying on Tellabs to innovate and to improve their ROI. In developing country markets like India where telecom service providers are struggling to make money due to highly aggressive consumer pricing, a company that provides solutions towards better utilization of their existing infrastructure and bandwidth resources should be an important supplier. In any business, if you are improving the ROI of your customer, no matter how ruthless the competition gets, it is reasonable to expect the business relationships to continue, unless the service provided is generic and easily substitutable. Sure, pricing pressures are always there, but the business is not going to disappear when you have such a diverse revenue base! Perhaps investors are concerned about Tellabs' net loss in 2011, due to charges for restructuring and higher investments. I believe these investments are for the future, especially when we consider the R&D spend for 2012. For the first 3 quarters of this year (Jan. 1 - Sept. 28, 2012), Tellabs has spent $179.4 million in R&D, which is an astounding 22% of its revenues for the same period. No company that does not believe in its future and while facing cut-throat generic competition in its core business would invest so much in R&D. If Tellabs rationalizes its R&D investments in the future to a 'mere' 10% of revenues (still aggressive for any company), this releases an operating profit margin of 12% of revenues even without considering any improvements in product mix and selling/administration/service costs.
The special dividend at nearly 40% of its closing stock price is, in my opinion, a clear signal Tellabs conveyed to the market that they mean business and care about their investors. There is a school of thought that if a company gives out so much in a special dividend, it means it cannot find enough investing opportunities for the future. That may be true in some cases but that's clearly not the case with Tellabs because it is attempting to 'create' its own future with massive investments in R&D from its own operating P&L. It could also mean that instead of squandering the $1.1 billion cash reserves on some over-priced acquisition that turns out to be a dud, the management feels sufficiently confident on its own organic growth prospects that it wants to return a chunk of it to investors. Note that even after issuing the special dividend, the company would still have over $700 million in cash reserves (covering 1.5 x current liabilities). The remaining cash is still worth about $2 a share. With the positive cash flows supported by strong balance sheet and declining number of shares outstanding over the coming months, a serious investor would consider buying TLAB at these levels.
To borrow and paraphrase the legendary investor Benjamin Graham, Mr. Market will eventually 'weigh' Tellabs for what it is worth though the daily 'votes' these days don't seem to reflect its true value yet.