Toad680

How Will the NBBI Stimulus Affect Small and Medium Cap Communication Stocks?

Understood, we have different approaches and we are trying to accomplish different objectives. I'm looking to pick the very best horse in the race. You are taking more of a basket approach and spreading your risk, while making sure to capture the benefit of the stimulus. Both can be very effective.

I agree wholeheartedly with you comment about the prestimulus depression in capex. Occam for instance hit 30 million in quarterly revenue prior to the stimulus and was profitable, but revenue has slowed to 20-22 million the last two quarters as everyone put plans on hold to evaluate the government program. As you know, a huge portion of their business is rural broadband.

So I think you are correct in your statement. There are really two near-term catalysts here for all companies in the space. 1) the stimulus dollars themselves (which I attempted to quantify in an earlier post), and 2) the resumption of normal spending patterns (and possibly catch up of several quarters of below trend spending) by the bulk of the market once winners are announced.

There was $28 billion of stimulus funds requested in the first round and only $4 billion (well, call it 5) is going out. Those not receiving awards will have to continue to build their networks and probably at an accelerated pace.

The sector is likely to get a very material bounce in the 4th quarter on the accelerated resumption of plans and what will probably be an unusually large budget flush year. Then in the first half of 2010 the actual stimulus dollars will be hitting the P&Ls of vendors geared to the space.

You are going to see some of these stock double and triple or more from here. You mention in your article that some of these stocks have already gotten their stimulus bounce. I don't think we've seen anything yet.


On Sep 07 09:49 PM Wisdom vs. Information wrote:

> gentleman, i am a strictly a trend trader, and i truly appreciate
> you adding some hard numbers. your numbers look good to me, so let
> me explain my style a little better.
>
> most importantly, i do not trust the gov't to continue the stimulus
> past the first tranche, thus i refuse to consider anything other
> than the first 7.2B. second, every one of these companies has different
> specialties, and third, each carrier has preferences, some of which
> are based upon nothing but familiarity. i started with market share
> per share to get a basic idea of who would get the best bumps. then,
> i am looking at this strictly in terms of fiber (the 58% estimate
> which i have seen as well), then who has what percentage of US fiber;
> finally, who deals with Tier 2 & 3 carriers? right there, i lose
> the ability to call hard numbers, so i begin to research who has
> been winning Tier 2 & 3 deals lately. now, i make arbitrary decisions
> based upon price value, competition and Tier 2/3 business.
>
> however, there is a larger problem with hard numbers that will blow
> away the effect of the stimulus, a reward for everyone who has read
> this far: Tier 2/3 have almost completely shut off cap ex this year
> waiting to find out how much stimulus each would get; thus, everyone's
> numbers have been hurt and shares depressed. so, consider what will
> happen to Tier 2/3 cap ex spending once the stimulus is announced?
> that is why hard numbers will have a hard time to breaking down bumps.

How Will the NBBI Stimulus Affect Small and Medium Cap Communication Stocks?

In the interest of fair disclosure, which you have posted on your intial article, I am long Occam (OCNW).

My thesis is that the company will run at 10% net margins on incremental business and possibly more than that on a big surge like the stimulus.

It has an Enterprise Value of $25 million. But it will earn over the next 3 years $30 million in net income from the stimulus alone and possibly more than that.

I think Occam will be multiples of its current share price over the next 12 months.

Others, like Zhone, will benefit greatly, but I think the large exposure to the stimulus that Occam has, coupled with the very low enterprise value will make it the best investment.

How Will the NBBI Stimulus Affect Small and Medium Cap Communication Stocks?

I will throw out a few guestimates. Let’s try to isolate access equipment vendors. Zhone has an estimate out that across all technology types, 58% of total expenditures if for equipment. Zhone further estimates that active elements are 35% of the total.

Maybe that’s high, maybe that’s not. But just to be conservative, let’s assume that only 20% of total broadband expenditures will be spend on active elements.

We know that a minimum of $7.2 billion will be spent on broadband in underserved areas, but possibly as much as double that. Again to be conservative, let’s just assume that it will be $7.2 billion.

That implies that active equipment vendors will be seeing 20% of $7.2 of funding provided by the government over the next three years. That equates to a stimulus to a small group of companies of $1.44 billion.

The estimates for market share of rural access that I have seen is the following for 2008:

Calix 37.8%
Occam 20.9%
Tellabs 19.7%
Zhone 14.2%

I don’t have any reason to believe that these market shares will change that much, with the exception of Tellabs, whose market share has been cut in half from 2 years prior and who has chosen not to focus on the access business in all its forms. So the other three probably stand to benefit from that in future share percentages.

But just using what we know from 2008, we can make a pretty reasonable guess at the revenue impact of the stimulus.

Calix $544 million
Occam $301 million
Tellabs $284 million
Zhone $204 million

These numbers could be higher if the stimulus is greater than $7.2 billion, if the active equipment components are actually closer to 35% instead of 20% and higher for Calix, Occam and Zhone if Tellabs continues to exit the access business.

I welcome your thoughts on the above.



On Sep 06 04:29 PM Toad680 wrote:

> Fair enough. My use of EV is based upon my own experiences and desire
> to put everything on an apples to apples basis before I start to
> consider other factors like margin structure, cash flow, break-even
> point.
>
> Given that we are also looking at companies in a steady state that
> are all about to be exposed to a similar catalyst, it helps to get
> a sense for the cost of the enterprise, because that can then be
> compared to the relative impact from the catalyst, which in my mind
> is the best measure of the delta here and of which stocks are likely
> to do better than others. For instance, if two companies with similar
> margin structures will get an incremental $50 million in business
> from the stimulus, but one has an EV of $25 million and the other
> of $250 million, There is clearly a lot more leverage to the stimulus
> for company 1 than company 2.
>
> But you are right, there are a lot of ways to skin a cat and it's
> not worth the time to debate the appropriate technique.
>
> What I like about Tesla's post is that he is starting to go down
> the road of measuring market share in the markets in which the stimulus
> will be spent. We know $7.2 billion will find its way into generally
> underserved areas for broadband. Some have suggested that the methodology
> for distributing the funds will actually leverage what is being handed
> out and result in up to $14 billion being spent. So somewhere between
> 7-14. Fine.
>
> Can we then break down the total dollar amount to the likely markets
> in which it will be spent ie access equipment vs laying fiber etc?
> We could then get a sense for the dollar amount going to specific
> market segments. Compare that to current market share in those segments
> and we will have a pretty goo idea of the company by company impact
> of the stimulus.

How Will the NBBI Stimulus Affect Small and Medium Cap Communication Stocks?

Fair enough. My use of EV is based upon my own experiences and desire to put everything on an apples to apples basis before I start to consider other factors like margin structure, cash flow, break-even point.

Given that we are also looking at companies in a steady state that are all about to be exposed to a similar catalyst, it helps to get a sense for the cost of the enterprise, because that can then be compared to the relative impact from the catalyst, which in my mind is the best measure of the delta here and of which stocks are likely to do better than others. For instance, if two companies with similar margin structures will get an incremental $50 million in business from the stimulus, but one has an EV of $25 million and the other of $250 million, There is clearly a lot more leverage to the stimulus for company 1 than company 2.

But you are right, there are a lot of ways to skin a cat and it's not worth the time to debate the appropriate technique.

What I like about Tesla's post is that he is starting to go down the road of measuring market share in the markets in which the stimulus will be spent. We know $7.2 billion will find its way into generally underserved areas for broadband. Some have suggested that the methodology for distributing the funds will actually leverage what is being handed out and result in up to $14 billion being spent. So somewhere between 7-14. Fine.

Can we then break down the total dollar amount to the likely markets in which it will be spent ie access equipment vs laying fiber etc? We could then get a sense for the dollar amount going to specific market segments. Compare that to current market share in those segments and we will have a pretty goo idea of the company by company impact of the stimulus.

How Will the NBBI Stimulus Affect Small and Medium Cap Communication Stocks?

Insead of looking at price to sales, have you considered EV/sales? Some companies are cash rich, while others are heavily leveraged. It makes for a big difference in who you would consider cheap and who you might not.

For instance, you mention Occam networks as being cheap. But with $2.10 per share in net cash, it's even cheaper on an EV/sales basis.

Others with a lot of debt are going to look more expensive.

It would be interesting, and perhaps more user friendly, to see these metrics in a table as opposed to sporadic mentions in the text. That way they could be compared and contrasted relatively easily.

Thanks for the comments. I agree with you that this space is in for a nice run.