ECI Telecom Ltd. (Nasdaq: ECIL) is one of the more battered stocks among Israel’s leading communications infrastructure companies. The share, which touched $12 at the beginning of April, has fallen 31%.
It began 2006 at $7.50 and is still above its January price, although this is scant consolation for those who bought it recently. In terms of value, the company began the year with a market cap of $892 million, rose to $1.43 billion at the beginning of April, and has since fallen back to its current market cap of $988 million.
These statistics give rise to a number of questions. First, why did the share rise so far so fast, despite the absence of material changes in the company’s business, and why did it take even less time to fall again? Second, given the sharp fluctuations in stock price during so short a period, how should an investor who believes in the company act? Why should he believe in the company at all, if its stock is going up and down at this rate? And third, is this behavior unique to ECI, or is it typical of all telecommunications infrastructure companies, from Lucent Technologies (NYSE: LU) to Alcatel (NYSE: ALA)?
These questions are extremely pertinent, because what has happened at ECI since the beginning of the year has nothing whatsoever to do with the company’s business or financial performance. I’ll try to explain what happened, and I’ll even try and predict what will happen next.
When you look at the ECI of today, you see a company with a clear, effective, and competitive strategy. This wasn’t the case back in 2000, since in practice the company had already begun to deteriorate much earlier. ECI’s business downslide actually began at the same as the stock was hitting highs in 1997-1999. Things apparently reached breaking point at this stage, since the company promoted then-CFO and former North American division manager Doron Inbar to the post of CEO.
When Inbar, then a relatively unknown figure on the capital market, took over in November 1999, ECI was priced at around $25. Two years later, it had sunk to $1.25. To be a CEO that leads a company down from a value of $25 to $1.25 is hardly a great achievement and certainly not a pleasant predicament to be in. So it was hardly surprising that when I met Inbar during those days of crisis, I was not convinced that he could extricate such a heavy wagon from the quagmire it was in. But he did, and with the help of Shlomo Dovrat and a top flight manager, he turned ECI from a company that was sinking to a company that is growing.
By 2005, sales had risen 26.8% to $630 million, more than three times the sales in 2004, with net profit totaling almost $40 million. So it was hardly surprising that when the stock market learned of ECI’s figures for the fourth quarter of 2005 and the year as a whole, the stock hit a five-year high of $12 a share, with the market cap soaring to $1.4 billion.
Since everyone is in agreement that no small amount of justice was done when the stock climbed back from $1.25 to $12, the argument at the end of March 2006 was about whether the stock had risen enough, or whether it was still cheap. To judge by what we see today, the stock has risen more than enough, since its current price is 31% lower than the price of two months ago. Is the latest fall a response to the gain, or are there other reasons?
ECI’s stock began to tumble immediately following the publication of earnings for 2005. It rose again just ahead of the publication of earnings for the first quarter of 2006, but these were disappointing, and the stock has been heading south ever since.
The company posted sales of $162 million in the first quarter, up 11.4% on the corresponding quarter in 2005 and that is fine. But they were also down 4% on the fourth quarter of 2005, and that doesn’t look good to the traders of 2006. Operating profit fell to half the operating profit in the corresponding quarter and was also down on the fourth quarter of 2005. Earnings per share fell to $0.03 from $0.10 in the corresponding quarter, and $0.07 in the fourth quarter of 2005, even worse from the point of view of those traders, who raised the stock ahead of publication of the reports, in the belief that the company would continue to beat the forecasts.
Rafi Maor, ECI’s new CEO was actually happy with the result. “This was an excellent start for us to 2006,” he said when summing up his verdict on the quarterly results, adding that the company would grow at a much higher rate than that of the industry as a whole. But investors dumped the stock en masse. Two companies that ECI has holdings in, Veraz Networks Inc., which specializes in telephony over IP networks, and ECtel Ltd. (Nasdaq: ECTX) are turning in strong performances in their businesses, and until recently, all the analysts continued to recommend the stock.
Lately, however, several things happened that “helped” push the stock downward. Since the beginning of June it has fallen 14%. This was caused primarily by the announcement that the company was about to raise $40-50 million an offering of five million shares. This is never a good thing for shares, especially at a time when the market is going through a rough period.
Then came Lehman Brothers analyst Marcus Kuperschmidt who lowered his own price and earnings per share targets. Kuperschmidt met with ECI management, then arrived at the conclusion that the target price would have to be lowered from $13 to $12 and expected earnings per share would also have to come down by one cent. What happened? They had, after all, explained to him that they didn’t really intend to make the issue but they had to put out the announcement otherwise they would have difficulty making share issues in the future, and would lose the right to make an issue at the right time (what is known as technical reasons only). So the issue shouldn’t have been a problem. So what exactly was it that caused the stock to take such a beating?
First, Kuperschmidt feared that fulfilling Deutsche Telekom’s (NYSE: DT) order for IPTV would take longer than expected, because of Deutsche Telekom’s protest against the Germany’s federal communications authority. Second, he saw a slowdown in the rate of implementing broadband orders even before the trend was seen on the ground. In short, he sees a drop of $0.01 in earning per share for 2006 from $0.41 to $0.40.
Despite all the shortcomings Kuperschmidt sees, the actual announcements so far are actually in line with the CEO. The question is whether, because all that has been written and read, ECI’s share should lose over a third of its value, or whether it should have risen as high as it did two months ago?
Why did ECI’s share reach $12 two months ago, unless it was boosted by analysts’ enthusiasm? Even Kuperschmidt agreed that ECI will have a good year in 2007 (where he gets the courage to make predictions for 2007 in such crazy times is beyond me, but he did), in which case the drop in the share has created a buy opportunity. But at what price? I can’t answer that. By the way, as far as telecommunications infrastructures are concerned, I really cannot understand what the analysts based their fears of a slowdown on.
You now have the answers to the questions I asked at the outset, briefly, and in order:
1. Why did ECI’s share seesaw so violently and in such a short period? Mainly because of analysts.
2. What should an investor do? Make his own checks, set up a price, and sit on the share.
3. Does the same hold for the entire sector? Of course it does. What did you think that the analysts there are any different?
Published by Globes [online], Israel business news - www.globes.co.il - on June 13, 2006
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