Should EZchip Be Considered A Solid Long-Term Investment?

| About: Mellanox Technologies, (MLNX)


EZchip reported increased revenues and operating margin in Q1’14.

Stock price increased 10% since the drop in September 2013 driven by Cisco’s nPower announcement.

Revenue mix is healthy and revenues increased from all customers except Juniper.

NPU roadmap presents a smaller cadence between product launches and promising new NP-5 and NPS products.

EZchip (EZCH), an Israeli developer of Ethernet network processors for networking equipment, reported its Q1'14 financial results on May 14. EZchip presented positive results for Q1'14 compared to Q1'13: revenues are 33% higher (also gross profit), operating profit is almost 100% higher, and net income is 50% higher. After the strong financials the company presented in the previous quarter, should EZchip now be considered a solid long-term investment?

Stock Analysis

As shown in chart 1 below, EZchip's stock price fluctuated greatly in the last twelve months between $32.42 and $22.24 and yielded a negative return of 7% for that period. In September of 2013 two events drove the EZchip stock price down by 20%: the first was Cisco's introduction of nPower, its new in-house network processor, and the second was speculation that ZTE plans to shift its NPU purchases from EZchip to other vendors. EZchip released a press release a few days later, clarifying that these two matters have no direct impact on EZchip financials, causing the stock price to increase slightly. From that point, EZchip's stock price traded around $24.9, yielding a 10% return to investors who bought the stock at the low $22.24 price.

The one-year target provided by research analysts ranges from $29 to $40 with $30.5 as the mid-point that reflects a 19% upside from the current price. That stock price increase should be backed with a revenues increase that impacts the bottom line, and EZchip is currently working to introduce two new products that are expected to expand revenues and increase net profit that should impact the stock price in the long run.

Business Analysis

In its Q1'14 earnings, EZchip reported increased revenues compared to Q1'13 and Q4'13 with increased revenues from ZTE, Cisco (NASDAQ:CSCO), and others; and a decrease in revenues from Juniper (NYSE:JNPR). As shown in chart 2 below, revenues from Juniper have declined since 2010 and are expected to decline in 2014 as EZchip forecast only a small portion of revenues from Juniper NP-2 purchases. Revenues from Cisco have increased in dollar terms year over year from $24M in 2012 to $28M in 2013; however, in percentage of total revenues, Cisco is down four points from 43% in 2012 to 39% in 2013. That trend continues into Q1'14 when the Cisco portion decreases to 33% of total revenue and increases in dollars terms compared to Q1'13 and Q4'13. The decrease in Cisco's portion of EZchip revenues is mainly attributed to the increase in ZTE revenues, which increased total revenues for EZchip but lowered Cisco's portion percentage wise.

This shift of revenues to Chinese giant ZTE has increased EZchip's presence in China and enabled the company to benefit from the technology boom in China. The revenues mix in Q1'14 seems healthier for EZchip than in previous years and no single customer is attributed to more than one third of the company's revenues. A decline in Juniper's revenues is offset by an increase in revenues from the smaller customers aggregated into the "others" category.

In the second half of 2014 EZchip will introduce NP-5 to the market, which is its next generation NPU in the NP product line to replace the legacy NP-4. NP-5 delivers twice the throughput of its NP-4 predecessor and one terabit line cards. ZTE, Cisco, and other small customers are expected to shift from NP-4 to the new NP-5 when it becomes available. NP5's forecast ASP is 60% higher than ASP for NP-4, so assuming customers maintain their existing volume from EZchip, the company is expected to increase revenues in 2015 in the NP product line. Towards the end of 2014, EZchip will release samples of its first generation product from the NPS product line that will be introduced to the market in 2015. NPS will double the throughput from NP-5, enabling two terabit line cards and C programming. NPS will be the first product to break EZchip's usual normal three-year cadence between generations and is supposed to reach out from the routing arena to data center network appliances, switch vendors, large carriers, and data center operators that are innovating in-house networking solutions. EZchip expects that NPS will double its TAM (NP and NPS) in 2016 and if the company can expand NPS sales outside the routing market it will be able to increase revenues dramatically. Maintaining two parallel product lines and supporting different types of customers will force the company to increase its R&D investment and customer support investment. If the increase in these two areas will be smaller than the increase in revenues in 2015 and 2016, the operating margin will increase and that will impact the stock price in the long term.


Holding EZchip for the last 12 months would have yielded a disappointing return for investors. However, since the company clarified the speculations around Cisco and ZTE, its stock price increased by 10% and is expected to increase by another 19% according to the research firms' mid-point price target. The one year cadence between the NP-5 and NPS introductions is a change from the historical three years cadence and may be a catalyst for increased revenues in 2015 and 2016. Some of these revenues will come from EZchip's traditional customers such as Cisco and ZTE, but the company is also targeting other customers outside the routing market. The ability to substantially increase revenues depends on EZchip's success in gaining new customers with the NPS and maintaining the same unit volume sales for the higher priced NP-5. All of these factors make EZchip a promising stock to follow and a good long-term investment to include in a technology portfolio.

Disclosure: I am long EZCH. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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