Calix (CALX – $6.52) has taken a beating in the last 5 months with the shares down 70% from $22. We spent some time going through the situation and have the following observations:
Good – Calix does have the right networking technology based on the latest views of how the broadband networking market will evolve. [See our recent report: Connected-Consumer - Ultra Broadband.]
Bad – The “government broadband stimulus windfall” hasn’t materialized in the US. This is basically the reason Calix has been such a disappointment. Their strategy was to capture a large portion of these funds and even acquired their most direct competitor, Occam Networks, to ensure that these free-flowing funds would end up in their coffers. But the funds have been anything but free-flowing. The company still insists that more of these funds will be available in 2012 and 2013.
Bad – Even with this major excuse and quite a few others (component shortages, environmental approval delays, prospects taking time to digest recent acquisitions and macro factors) the management team has not executed well or set expectations appropriately. Painting a picture of your company as a victim of external circumstances and market factors is not a way to inspire confidence.
Bad – The single most important factor driving the low Calix share price and valuation is their consistent practice of losing money. For the past several years the company has lost $15-20M per year on $200-250M in revenue. Recently there has been some growth on the top line and gross margins have improved a bit to about 44%. Based on discussions we have had with people in the company it would have been possible to be profitable in this revenue range but management has tended to spend ahead of demand rather than wait for it to materialize.
Bad – Adding to investor concerns is the large size, consistent growth and high margins of competitive companies like ADTRAN (ADTN – $28.59). ADTRAN is posting 58% gross and 27% operating margins on just over $700M in revenues. Just today ADTRAN announced that they were acquiring the Nokia Siemens Networks Fixed Line Broadband Access business.
Mixed – For better or worse Calix has had the benefit of strong leadership and long-term vision from their CEO, Carl Russo, since 2002. Mr Russo is joined by a broad operational team, many with backgrounds from companies like Cisco. The company also has a strong board of directors. Frankly Calix has the management infrastructure for a company 3-4x their current size. While that can be a good thing in a high growth scenario it might be too expensive and a bit “top heavy” for the growth environment they are in.
So is Calix a bargain here at $6.50?
Based on our intrinsic valuation analysis it appears oversold but not by a huge margin. We estimate the shares to be worth $7.50 based on current fundamentals.
The core issue remains profitable growth. We’ve factored in a steady but slow improvement in operating margins and efficiency gains in both SG&A and R&D. However their recent decision to expand fairly aggressively in Europe will add materially to expenses without driving much near-term revenue so operating expenses are not likely to come down as much as they otherwise would.
Our 20x multiple is generous enough so unless the company begins to generate sustainably higher growth and more determination to drive operating margins the shares will remain range bound around our $7.50 IV.
Strategically Calix is in the right place but operationally they are set up to be running a $500M company growing 40% and instead they are a $350M company growing at 15%. Wouldn’t take too much to fix but we have no visibility as to if and when they would happen. Meanwhile investors would have to rely on a major uptick in global broadband spending growth to lift them into a higher bracket of profitability. That’s too much uncertainty for our taste.
[Disclosure: The author is an LP in a venture fund that still owns some shares of Calix.]