Recent IPO Cavium Networks: Great Technology, High Price Tag

On May 2, Cavium Networks (CAVM), which makes semiconductors used by communications equipment vendors such as Cisco Systems (CSCO) and F5 Networks (FFIV), was taken public by Needham & Co., Lehman Brothers, JMP Securities, Thomas Weisel Partners, and Morgan Stanley, and Monday — Surprise! — four of the five bankers initiated coverage with enthusiastic views for the company’s technology, but rather lackluster views on the shares, which are expensive.

Thomas Weisel Partners’s Jeremy Bunting says Cavium’s customers will become increasingly dependent on the company’s chips because of high switching costs to use competitors’ chips, and that “stickiness” should help Cavium gain more and more of Cisco and others companies’ business over time. Still, trading at 47.3x Bunting’s estimate for 42 cents a share in profit next year, the stock is fairly valued, he says, and he gives the stock a Market Weight rating.

Lehman Brothers analyst Tim Luke is, like Weisel’s Bunting, somewhat reserved, giving the shares an Equal Weight rating. He says that while Cavium is becoming a leader in a new category in high performance security and networking chips, and its sales growth is impressive, the stock would be better bought on a pullback. His target for the stock is $22.

Needham & Co.’s N. Quinn Bolton is a bit more excited, giving the shares a Buy rating and a $25 12-month price target, or 25% above the current price. Bolton says the company’s chips are “uniquely positioned” to make network switches more aware of the applications data that flows through those switches, and that the company’s chip designs will be able to sell into a range of equipment from high-priced to low-priced. His discounted cash flow model is the basis for the price target, and his 45 cents a share estimate for next year is slightly higher than Bunting’s, giving the stock a $43.8x forward P/E — still rather rich in my view.

I’ll have more to say if and when I get my hands on JMP Securities’s Krishna Shankar’s and Deutsche Bank’s Arnab Chanda’s respective reports in hand. But you get the idea: exciting upstart company, big price tag on the stock.

Cavium shares are up about 22% since last month’s public offering.