The communications equipment industry contains some of the riskiest investments. They tend to be at least 50% more volatile than broader indexes and thus have a wide variance between upside and downside. As an investor relations consultant, I believe that bull cases overwhelming characterize smaller under-followed companies, like Augme Technologies (AUGT.OB) and MediaG3 (OTCPK:MDGC). As press coverage improves for these firms (and I plan on writing focus pieces), they are bound to go skyward.
In the meanwhile, a disproportionate amount of attention will be placed on larger firms like Juniper (JNPR). In this article, I will run you through my DCF analysis on Juniper and then triangulate the result with an exit multiple calculation and a review of the fundamentals compared with Alcatel-Lucent (ALU) and Cisco (CSCO). I find that Juniper is significantly overvalued.
First, let's begin with an assumption about revenue. Juniper finished FY2011 with $4.4B in revenue, which represented an 8.7% growth off of the preceding year: deceleration. Analysts model a 13.4% per annum growth rate over the next half decade, and I view this as overly bullish given thetas around 300 bps greater than what is expected for the S&P 500 (NYSEARCA:SPY).
Moving onto the cost side of the equation, there are several items to consider: operating expenses, capital expenditures and taxes. I model cost of goods sold, SG&A, R&D, and capex as 34%, 26%, 22.5%, and 4.5 - 4% of revenue, respectively. Taxes are estimated at around 25% of adjusted EBIT (excluding non-cash depreciation charges).
We then need to subtract out net increases in working capital. I estimate that this will hover around 4% of revenue.
Taking a perpetual growth rate of 2.5% and discounting backwards by a WACC of 10% yields a fair value figure of $16.40, implying 26.8% downside. This WACC is more than reasonable given that the company is nearly 150% more volatile than the broader market. The market, however, seems to be factoring in a WACC of 7.5%.
All of this falls within the context of significant uncertainty:
Juniper's revenue growth was 9% for 2011. Annual revenue for 2011 represented a new record for the company. Profitability was solid, though lower than expected. Our Q4 results felt the effect of increased macro volatility that escalated over the second half of the year due to the sovereign debt concerns in Europe and slowing recoveries in APAC countries as well as the U.S.
Here on our U.S. business, we saw a number of our largest customers reduce their spend within the quarter, including Tier 1 service providers and financial services. Though on other sectors like Federal, we saw stronger spending than expected.
From a multiples perspective, Juniper is also expensive. It trades at a respective 28.7x and 18.1x past and forward earnings versus 7.4x and 6.9x for Alcatel-Lucent and 16.5x and 10.6x for Cisco. Assuming a multiple of 16x and a conservative 2013 EPS of $1.18, the rough intrinsic value of Juniper's stock is $17.70.
Consensus estimates for Alcatel-Lucent's EPS forecast that it will fall by 40.4% to $0.28 in 2012, grow by 21.4% in 2013, and then fall by 52.9% in 2014. Assuming a multiple of 10.5x and a conservative 2013 EPS of $0.31, the rough intrinsic value of the stock is $3.26, implying 38.1% upside. The reason why Alcatel-Lucent is so cheap is because, unlike Juniper, a significant degree of risk has been sufficiently factored into the stock. With the earnings decline and volatile market, much of the downside has been reflected in its low multiples.
Cisco, however, merits trading at a premium to peers due to its strong brand and sustainability. Consensus estimates for its EPS forecast that it will grow by 13.6% to $1.84 in 2012 and then by 8.2% and 7.5% in the following two years. Assuming a multiple of 15x and a conservative 2013 EPS of $1.95, the rough intrinsic value of the stock is $29.25, implying 38.8% upside. For a company that is safe, this upside calls for a "buy." Thus, Alcatel-Lucent and Cisco are, in my view, likely to outperform Juniper as the economy shifts into full employment.
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