Analyzing Smith Barney's Top Telecom Picks

Last week, Smith Barney published an interesting round-up of their recommendations for telecommunications equipment companies in the first half of 2006. Topping their list are F5 Networks Inc. (Nasdaq: FFIV), which competes with Radware (Nasdaq: RDWR) in the network data traffic sector; Sonus Networks, Inc. (Nasdaq: SONS), which competes with AudioCodes (Nasdaq: AUDC) in the VoIP equipment sector, and lastly, leading optical components supplier JDS Uniphase CP (Nasdaq: JDSU), which will publish its second quarter report today.

Smith Barney says that as the second half of the year is likely to see an economic slowdown, it advises investors to focus on companies that excel in their respective fields, and thus it listed the aforementioned companies. Commenting on Radware, Smith Barney rates it “Buy” but says this is because of its low value, relative to the volume of cash it has, around $9 per share. Smith Barney is waiting to see whether the managerial/operational changes introduced by Radware will filter through to the profit line, before it adopts a more aggressive stance on its rating for the company.

As mentioned earlier, Smith Barney prefers F5 over Radware in the network data traffic category, despite F5 being on the long list of companies conducting reviews of their options policies, and facing possible delisting from Nasdaq as a result. Smith Barney believes that F5 is holding its own against bigger competitors such as telecommunications equipment giant Cisco Systems Inc. (Nasdaq: CSCO), or the new player in the field Citrix Systems Inc. (CTXS), which has pleasantly surprised everyone with its sales, while simultaneously increasing the ratio of new orders to deliveries. The upcoming launch of a new product will, it feels, guarantee its continuing positive momentum.

As for the VoIP equipment category, Smith Barney notes the large-scale investment by enterprises and service providers, and it therefore rates Sonus “Buy,” while rating its Israeli rival AudioCodes “Hold”, adding that it may become more interesting as the year progresses. Perhaps this is a hint that AudioCodes will indeed be upgraded to “Buy” in a few months time. Interestingly, Sonus, like F5, has been recommended despite the fact that it too is having problems with its filings because of its options allocations, and could also be delisted from Nasdaq.

Smith Barney considers Sonus the undisputed leading provider of VoIP equipment to telephony companies, after it reported an impressive increase in sales in the June quarter and an orders backlog that has grown faster than its deliveries. Smith Barney expects Sonus sales to increase by 10% in the second half of 2006, with a sharp rise in orders from customers in Japan such as KDDI Corp, and perhaps also NTT Communications Corp. This specific forecast for Sonus corresponds to what I have predicting in Japan for Orckit Communications (Nasdaq: ORCT), whose equipment supports VoIP equipment roll-outs, since Internet telephony is one the three services known as ‘Triple Play.’

Cisco, one of the Smith Barney team’s recommendations, is already in my portfolio, and today I am adding the fourth on their list, JDS Uniphase. JDS was in my portfolio at the beginning of the year, but a sudden 30% rise within two weeks following an aggressive recommendation by James J. Cramer caused me to sell. This proved to be a wise decision, since the stock subsequently plummeted from $4.30 in March to a low of $2 a month ago. It has now rallied to $2.58, ahead of the publication of the company’s second quarter report today.

JDS controls one quarter of the optical component market for the telecommunications sector, which as everyone knows, is investing billions of dollars in optic fiber-to-the home [FTTH] networks. It also controls 50% of the niche for more expensive components. Since its major collapse during the bubble, JDS has undergone extensive restructuring, including the firing of tens of thousands of employees mainly at factories it operated in Canada, a small number of which have since been re-opened in China. JDS also acquired a company which manufactures testing and measuring equipment for telephony companies, a move that greatly reduced its total dependence on the volatility in the component sector.

Usually, I don’t like to add a new company to my portfolio just as it is about to publish results, but I feel that the expectations from JDS this time are fairly low, in line with the low stock price, so I won’t suffer too much damage even in the event of an unpleasant surprise. The market expects JDS to post sales of $314 million for the June quarter, and to reach break-even in its profit line, compared with a loss in the same quarter last year. Smith Barney predicts that JDS will move to profitability in the upcoming September quarter for the first time in five years.

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.