Orckit: Not Wrong on Its Rights

Includes: JNPR, MLNX, ORCT
by: Shlomi Cohen

Two interconnected Israeli firms held in my portfolio, tracked by "Globes", were hit this past week: Orckit Communications Ltd. (Nasdaq: ORCT), which buys EZchip (Nasdaq: EZCH) processors for two of its three platforms, fell after it published a shelf prospectus for a rights issue; and EZchip paid, over 10 days, a "fine" of over $100 million in market capitalization, for an event which should have been celebratory.

EZchip was covered for the first time by respected investment house Jeffries & Company, and the report revealed to the company and its investors that major customer Juniper Networks (Nasdaq: JNPR), which until today contributed about half of all EZchip's revenue, is on its way out as a customer.

Jeffries analyst Adam Benjamin gave EZchip a target price of $18 and a "Hold" rating, and it can be asked if, at a price of $11, the share shouldn't already be a "Buy".

About two months ago, I estimated that Orckit was on the way toward a rights issue, and it will apparently take place at the end of next month, after second quarter results and a shareholder meeting. Orckit has been a company where, after its 1996 IPO, each time it has raised funds, investors reacted with "Why, what for?", and after 1-2 years, with "It's great that they raised funds". If convertible debt of $120 million would not have been raised a decade ago, there would be no company today. If the company would not have raised $25 million in convertible debt about two years ago, the share would trade today at levels similar to Metalink Ltd. (Nasdaq: MTLK) and others - $0.10.

I believe that as of the end of June, the company had $50 million in the bank, and this time the funding is coming not only because of the need to raise an immediate $20 million to strengthen its balance sheet, but also because of the owners' desire to increase their relative holding in the weaker days of July-August. Remember, they did not hesitate in the first quarter to buy back convertible debt at a cost of $3 million, out of a cash balance that is being drained at a rate of $5-6 million per quarter. The investment, in my opinion, was very wise, because it also eliminated over $6 million in debt, which also strengthened the balance sheet.

Those who sell Orckit shares today, like in most case of rights issues, and intend to use the proceeds to buy the rights when they are tradable, apparently did not read the fine print of the prospectus. That's where it says clearly that the rights will not be traded. Whoever holds Orckit shares on the record date, and doesn't exercise their right to invest, will not be able to sell the right, and will remain with the same stake that was held beforehand.

It's interesting that in the last two weeks of June, before the prospectus was published, short interest in the share on Nasdaq rose ten-fold, even if from a low level of 20,000 shares.

Orckit owners CEO Eric Paneth and chairman Izhak Tamir, who today only hold 15% of the company (not including out of the money options), reported in the prospectus that they intend to buy the full amount they can with the rights they are allocated, and will even invest more if there are investors who will pass up their right. In this way, Paneth and Tamir have a clear opportunity to increase the stake they own in the company, at prices that they would not be able to get in regular trade when speaking of large quantities.

There is no doubt that Orckit owners think they have a company whose valuation should be several times higher than its current $50 million. With "captive" customers such as KDDI, Germany's largest cable company, Korea's SK Broadband, and soon possibly a large Indian customer, in addition to its new small platform which is gaining traction, albeit from a low level of sales, they believe that after the telecom crisis, unknown to anyone when it will end, the results will arrive, and so each one is investing several million dollars.

Published originally by Globes [online], Israel business news - www.globes.co.il

© Copyright of Globes Publisher Itonut (1983) Ltd. 2006. Republished on Seeking Alpha with full permission.