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