Veraz Networks: Another Tech IPO Coming Public Too Soon

On April 1, Bill Simpson wrote an analysis of Veraz Networks (VRAZ). On April 5, Veraz sold 9 million shares, closing below its initial public offering price of $8, which fell well short of the expected range of $10 to $12 a share. The stock is now trading at $6.96.

The text of Mr. Simpson's original writeup follows:

• • •

Veraz Networks plans on offering 9 million shares at a range of $10-$12. Insiders will be selling 2.2 million shares in the deal. Credit Suisse and Lehman Brothers are lead managing the deal, Jefferies and Raymond James will be co-managing.

Post-offering VRAZ will have 39.5 million shares outstanding for a market cap of $435 million on an $11 pricing. IPO proceeds will be utilized for capital expenditures, working capital and for general corporate purposes.

ECI (ECIL), the selling shareholder, will own 25% of VRAZ post-ipo.

From the prospectus:

We are a leading global provider of Internet Protocol, or IP, softswitches, media gateways and digital compression products to established and emerging wireline, wireless and broadband service providers. Service providers use our products to transport, convert and manage voice traffic over legacy and IP networks, while enabling voice over IP, or VoIP, and other multimedia communications services.

IP Products:

ControlSwitch softswitch solution - Manages and directs the IP traffic (such as a voice call) to its appropriate destination, whether it starts out as IP traffic or is traditional traffic that has been converted.

I-Gate 4000 family of media gateway products - convert traditional telephone voice traffic into IP, compress the data packets and transport this data on IP networks.

The two product families work in conjunction with each other and according to the company,

convert traditional voice traffic to IP and back, allowing our customers to operate two distinct networks as a single network and thereby to continue to utilize their existing wireless and wireline legacy networks while simultaneously offering next generation IP applications and services.

Advantages include:

1) seamless migration of legacy networks to IP;
2) cost reduction;
3) rapid introduction of new services;
4) compatibility with current systems.

Legacy Products:

Digital circuit multiplication equipment [DCME] - Communications systems that use proprietary signal processing technology to increase the effective capacity of transmission links by compressing voice and fax traffic while maintaining the quality of that traffic.

While DCME products made up 38% of revenues in 2005, they've been declining in recent years. The growth driver for VRAZ has been its IP products which doubled in revenues in 2006. VRAZ is leveraging its installed base of DCME customers to position to be the provider of IP network solutions to customer bases as they migrate to IP networks.

Much like a slew of recent tech ipos, VRAZ is a play on the increased traffic growth over networks and the upgrade cycle of said networks by service providers. Pushing this growth is increased subscriber demand for advanced voice, video and data telecommunications services and the broad adoption of broadband.

Customer base includes 400 service providers that have deployed VRAZ DCME products and 55 customers that have deployed VRAZ IP products.

As with most of the networking sector, competition in the Internet Protocol space is fierce. Direct competitors to VRAZ include Alcatel-Lucent (ALG), Ericsson (ERIC), Nortel Networks (NT), Siemens (SI), Cisco Systems (CSCO), Sonus Networks (SONS), Tekelec (TKLC) and Huawei. Note that this has also been a notoriously cyclical sector. Business for IP networking products has been robust the past few years. However even in a robust environment, VRAZ has never been able to book a profit. Another cyclical slowdown at some point in the future would hurt a company like VRAZ a great deal.

VRAZ sells its products mainly through resellers and distributors. VRAZ's largest shareholder ECI has been responsible for generating 25%-30% of VRAZ's sales the past two calendar years. 82% of revenues are derived outside the US. Much of VRAZ research and development staff is based in India.

Flextronics (FLEX) manufactures all of VRAZ's IP products, largest shareholder ECI manufactures all of VRAZ's DCME products.

Financials

$2 a share in cash post-offering, no debt.

Revenues have been increasing annually the past few years solidly if not spectacularly. All of the growth has been fueled by VRAZ's IP products. Its legacy DCME products appear to be slowly drying. DCME product revenues have declined each of the past two years and are expected to once again in 2007. In comparison, IP product revenues have doubled the past two years.

2006 - Total revenues were $99.5 million, a 30% increase over 2005. All of that revenue increase was due to VRAZ's IP product line. Gross margins were 54%, a decline from 2004/2005's 56%. Led by R&D and sales & marketing, operating expenses were hefty at 58% of total revenues. Operating expense ratios have really not declined all that much the past few years as revenues have increased.

This is just not what one wants to see. Unless VRAZ either ramps revenues much faster than it has been or somehow manages to lower operating expense ratios, it'll never be able to put much on the bottom line. Losses in 2006 were steep at $0.34. VRAZ did approach break-even in the fourth quarter of 2006, however it's noted a few times in prospectus that it expects hefty losses to resume the first quarter of 2007.

2007 - VRAZ expects DCME product revenues to continue to decline, so revenues growth will depend on its IP products line. It appears VRAZ did not have a stellar first quarter of 2007. In fact it expects overall revenues to decline sequentially in the first quarter of 2007. Why? Apparently its IP product revenues did not grow in the first quarter of 2007. So we've got an operation losing significant monies whose growth driver looks as if it may have stalled...at least for a quarter. I would expect 2007 revenue growth here to be in the 10%-20% range overall. Losses should be in the $0.25 - $0.35 ballpark.

Conclusion - VRAZ is another tech ipo coming a bit too early. The revenue growth and steady losses just do not justify appreciation from ipo range. Pass.

Comments

[Totally a b...:]

I am not convinced that you are giving VRAZ no chance even at the current price levels even though it is growing its core softswitch business 100% Year over Year. Veraz has specifically mentioned in their S1 that Mar 07 quarter (being the 1st quarter) is a seasonally slow Q and revenues can be down sequentially from the earlier quarter. But is it not standard filing practise and built into the price & estimates?

And if we start reading into such fine prints and take such a short term and narrow view, I am pretty sure you would want to run away from all IPOs, nobody would ever want to invest in IPOs.

Why would you not comment on their main competetion and their valuation? Here, I will do it for you:

VRAZ: Market cap $250 mil - 2006 revenues - $100mil, trades at 2.5x times revenues and 2x expected 2007 revenues of $120-$130million. $81 mil in cash, no debt. Enterprise value $170 million.

SONS: Market cap $2 BILLION - currently delinquent in filings with SEC - 2006 revenues not known- estimated @ $220 million - trades at 10x times 2006 revenues. $200 mil cash. EV $1.8 billion.

So can you justify why SONS with just over double the revenues is trading @ 10 times valuation that of VRAZ. I believe it has do with 2 reasons:

1. Profitability which VRAZ will be soon.
2. VOIP/Softswitch market is currently at $2 billion growing @ 36% CAGR and expected to reach $10 billion by 2010. And with 400 US & international DCME customers, I am pretty sure that VRAZ will get a big pie of that as these customers continue to overhaul/upgrade their legacy networks.

Also I believe with your negative & narrow term view, VRAZ selling to international Tier I/II customers is a bad thing. And I would say HELL NO! Given the recent Dollar weakness againsts all major US currency, VRAZ stands to in fact gain a heck lot from it given that it derived 80% of its 2006 revenues from International market.

2007 Apr 23 04:20 PM

[Totally a b...:]

BTW, if you are upset that you missed out on buying at the lows and hence want to talk it down for you and your subscribers (I believe 100 or so), I can totally understand your mentality. VRAZ closed up another .47 cents (8%) today. Ouuch! So I guess nobody cared of your above opinion today, Double Ouuch !!!

2007 Apr 23 04:28 PM

[Totally a b...:]

"It appears VRAZ did not have a stellar first quarter of 2007. In fact it expects overall revenues to decline sequentially in the first quarter of 2007. Why? Apparently its IP product revenues did not grow in the first quarter of 2007. So we've got an operation losing significant monies whose growth driver looks as if it may have stalled..."

Right day trader! You really had the nerve to make such a speculative and misleading statement. Check out the earnings, their core IP revenues increased 98% annually and 18% sequentially. Revenues increased 27% compared to the prev year. Both earnings and revenues blew past estimates.

If you want to maintain the slightest bit of creditability, accept that you were seriously wrong and applaud the results!

2007 May 08 05:41 PM

[bill simpson:]

Think you need to gain a little objectivity, your subjectiveness in regard to this ticker appears to have clouded your judgement. I don't care for the derogatory comments about me by the way. no need to get personal simply because I disagree with you about this ticker. I don't have the power to 'walk' or 'talk' down ipos to gain better entry, that is not what I do. I wrote the above analysis pre-ipo based on the valuation of initial $10-$12 pricing range. VRAZ closed today at $5.88 today for what it is worth.

I wish you well, appears you are quite green in the markets. Always painful lessons to learnm we've all learned them at one time or another. I would ask though to please keep personal attacks out of comments on pieces. thank you.

2007 May 15 08:26 PM

[Totally a b...:]

"I don't have the power to 'walk' or 'talk' down ipos to gain better entry, that is not what I do."

Actually, investors do read columns which appear right below the ticker's quote. I have read quotes from your blog about VRAZ bad Q1 on Yahoo Finance boards posted by other people as a -ve. I am not sure how much it has hurted the stock, but it has.

Yes, @ $11-13 IPO price, VRAZ was expensive and I give you that. But you were VERY wrong mis-leading investors about VRAZ possibly having a bad Q1. It had misled me into selling VRAZ before earnings. But then they handily beat expectations and delivered solid revenue growth YoY. And I bought in again after that for a discount.

You still do not accept that you made a seriously wrong speculative statement, you were talking as if you already knew the numbers:

"Why? Apparently its IP product revenues did not grow in the first quarter of 2007.So we've got an operation losing significant monies whose growth driver looks as if it may have stalled..."

It grew 98% YoY and 17% sequentially.

And about calling names, I apologize, but please educate your readers that when you write IPO columns, you are merely speculating them for a quick gain - flipping and that you are not in for the long term like many of the investors like me are. So naturally your writeups does have a lot of narrow and negative tone for IPOs which you do not expect to pop at open. In short let your readers know your trading objective and/or investment profile.

2007 May 21 05:20 PM