While front- line cellular companies get most of the attention, lesser-known companies like Ceragon Networks (CRNT) grow by making the infrastructure wireless products that connect cell phone towers to other towers. The majority of their products sell to about 230 cellular companies such as AT&T, Hutchinson 3 and Reliance.
In the five years ending 2010, Ceragon grew 23 percent CAGR to $249.8 M.
Ceragon was a newcomer to this business in 1996, competing and growing successfully against large and established competitors like Aviat (AVNW), Alcatel Lucent (ALU), Fujitsu (OTC:FGELF), Ericsson (ERIC), NEC and Nokia (NOK). They acquired their competitor Nera from Eltek S.A. in late 2010 for $48.5 M. In 2010, the Nera business generated approximately US $280 million in revenue, but revenues had been decreasing annually.
Although based in Israel, the company does the majority of its business in Asia (mostly India) and EMEA and through OEMs.
The wireless backhaul business, although decades old, has found some new life in the past few years as cellular carrier companies are having to ramp up their data capacity rapidly to accommodate smartphones and iPads. At the same time, most carriers are planning to convert to HSPA and LTE and while carriers are upgrading their cell towers, they tend to upgrade their backhaul at the same time.
Maravedis, a market research company that has long focused on the backhaul market reported in May,2011 that the microwave backhaul equipment market is expected to surpass US$ 12 billion by 2016. During 2010 they stated PtP microwave backhaul market reached US$ 4.74 billion.
They also estimated that "During the next 5 years the microwave market will continuously grow, mainly driven by the need for operators to deploy new base stations to provide good quality of experience over LTE networks."
Significantly, they stated that "pure packet will account for 90% of annual microwave radio shipments by 2016."
Ceragon still has only a small market share in the wireless backhaul business. They have been competitive in an industry that is several decades old and they have prospered through an ability to have leading edge products, competitively priced and through being innovative in building channel partnerships. However, the older line companies are gradually getting caught up as they produce more competitive products.
Ceragon market share is still only a small fraction of the total market. If they continue to execute well, there is much more market to be exploited. Ceragon's focused effort on this market contrasts well with the larger multi-product competitors who have relied to an extent on their old relationships within the carrier industry.
Ceragon growth rates
The one year growth rate of Ceragon will be difficult to predict until the acquisition of Nera is somewhat digested, the health of the former Nera business is assessed and the ability of Ceragon to maintain former Nera business is established. Profitability in the next year will be particularly hard to establish as the needs of the consolidated business are sorted out and any first year consolidation and write-offs are flushed out.
Longer term, we are assuming a similar growth rate to what Ceragon has recently been achieving can be resumed. We believe Ceragon will continue to take market share from the incumbents and that the market for backhaul will continue to be robust as the front line mobile carriers move toward high data rate LTE systems.
There will be a large jump in 2011 revenue due to the Nera acquisition and we've assumed long term revenue growth at the 12 percent rate over the next several years. Ceragon has maintained higher rates than this in the past, (23% in the last five years) but as a larger company, high growth rates may become more difficult to maintain.
We've assumed that long term after tax profit margins will be impacted for the next two years, as Ceregon "digests" Nera, but grow to 7% for the long term. Perhaps Ceragon could do better than this, but management have not demonstrated that ability in the past five years. In this industry a seven percent net income could be a challenge, as there is significant price pressure due to the nature of the business. An example of this is that Ceragon is doing a lot of its business in cost-sensitive India. Also, it is facing competition from some large and aggressive competitors and a large portion of its business is coming from large (price aggressive) transactions and OEM sales.
Thought the 2008 to 2010 period Ceragon was able to increase gross profits from 33.4% to 35.8%, however in the same period Opex increased from 27.4% to 30.2%, much of that through increased G&A expenses. We would like to see a little more control over Opex. The next 12 months will be revealing as Ceragon finds economies from the Nera acquisition.
Inventory levels seem under control, with fairly flat growth relative to revenue growth.
With the company going through rapid change, we would like to see quarterly reports with detailed and timely SEC filings. The first quarter has been released for six weeks, without any detailed SEC filing.
Risk Assessment: Speculative
We assess Ceragon's risk level as speculative
On the positive side, the company has a history of rapid growth in a competitive market, in spite of competitors with entrenched relationships. They have been a positive cash flow generator.
On the negative side, the company is growing through acquisitions, with limited transparency as to how well profitability can be managed. They have been successful partly by being aggressive in markets which have higher pricing pressures. They are surrounded by larger and hungry competitors. Lastly although the management team has established its ability to grow revenues, they have been less successful at demonstrating consistent cost control and profit growth.
Ceragon's single minded focus on this industry has been a strength given the current growth opportunity in cellular backhaul, but also leaves them quite exposed to a single market and single type of customer, with little diversification.
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We assess stocks primarily based on their fundamental value. We estimate the revenue and earnings to be generated by a company over the next ten years. We look at the risk involved in the business, look at the assets and liabilities and we discount the value of the future earnings according to risk level. For companies with medium to high risk levels, we discount the value of future earnings more aggressively. Finally, we compare the value of those future earnings to the stock price. Are the shares "on-sale" – or are they expensive?
As Ceragon swallowed the Nera fish, Ceragon themselves could be an acquisition target as one of the large competitors decides to expand their product line. With a market cap of about 400 million, they aren't too large to be acquired.
Conclusion – Speculative Buy
Ceragon is a strong competitor with solid products. The market in which they focus has legs for many years to come.
Although the buy would be speculative, we believe the stock is priced to move and would recommend to buy at any price under $13.