Tellabs: Out-of-favor value stock in tech land
The selling pressure is past us now and the company presents an attractive investment.
By Manoj M. Nadkarni, CIG
Sometimes best investing opportunities can be found among technology stocks that are out of favor. Can Tellabs (TLAB), provider of hardware, software and services to telecom industry, be one of those cases? We think so. Tellabs stock was removed from the S&P Midcap 400 index as of the end of last month. There was selling pressure as ETFs rebalanced but that is past us now. Last Friday, Tellabs appointed Lawrence Rieger as new acting CFO. As a partner with a leading accounting firm, Rieger has worked closely with Tellabs since 2003, which should help.
Tellabs makes equipment to handle voice and Internet data traffic for metropolitan areas, for mobile backhaul (transmitting data from cell sites to main network) and for routing / access at customer premises. It enables telecom carriers to serve customers over fiber connections.
During 2012, the company saw the biggest slowdown in the data segment, down 36% from the prior-year levels. This was primarily due to loss of mobile backhaul business at AT&T (T) to rivals Cisco (CSCO) and Alcatel-Lucent (ALU) beginning in early 2011. Tellabs has performed well at telecom providers in Europe (Vodafone, NetCom), Russia (MTS) and Latin America (Telefonica).
Its main competitors are Cisco, Juniper Networks (JNPR), and Alcatel-Lucent. Verizon (VZ) remains Tellabs' top customer with about 25% of total revenues. Tellabs has refocused its research and development efforts and has been improving its cost structure, which are encouraging signs.
Our investing decisions are based on four key areas: valuation, growth prospects, profitability, and quality of management. Here's why we like Tellabs
Valuation: The company's enterprise value (EV) is low, about $162 million (at stock price $2.06). The EV-to-sales ratio is only 0.16, one of the best among tech stocks. The only drawback: Tellabs is not profitable. If it were profitable it would be trading at higher multiples, typically EV-to-sales above 1.25. The company has about $571 million ($1.60 a share) in net cash and equivalents, so we believe the downside is low.
Table 1 shows comparison between Tellabs and its peers and competitors. TLAB's EV-to-sales is attractive compared to Cisco and Juniper. Ciena and Alcatel-Lucent are burdened with heavy debts and goodwill/ intangibles, so their book values are negative. TLAB has excellent intrinsic value; it is trading below net tangible book value. Cisco's profitability is high to justify its multiples.
In early 2013, Tellabs repatriated non-U.S. cash of $375 million to U.S. with very little tax liability. Unlike other cash-rich companies (Apple, Cisco), the majority of Tellabs' cash is on-shore.
There is likely to be consolidation among telecom suppliers. Tellabs' low valuation, its technology and its intellectual property, including patents, make it an attractive candidate for acquisition by a peer or competitor serving similar end-customers.
Growth prospects: The company expects the June quarter to be the trough, with revenue rising in the second half of 2013, based on customer engagements. Tellabs' legacy business has suffered, but there are a few bright spots such as optical LAN (using optical cables for local area networks), and the potential for SDN (software-defined networking). The company has had success with optical LAN installations at U.S. government facilities. Its SDN platform for new services will be available with 8xxx- and 7100-series devices by early 2014. The AT&T business has dropped to 5%; further downside is not much.
Tellabs provides infrastructure for two critical trends -- Internet bandwidth growth and increased use of mobile devices. Their total market should expand. The Internet is migrating to tablets where 4G wireless connectivity is growing. Competition to iPads from Samsung, Amazon and others drives down prices. As tablets sales rise, so does demand for 4G, a favorable trend.
Profitability: This is a negative factor suppressing the stock price. Tellabs is cutting operating expenses aggressively to lower break-even.
Management: 2012 was a transition year. Very sadly, Tellabs CEO Rob Pullen passed away in July 2012 of cancer after a long illness. The company appointed Daniel Kelly as the new CEO. In May 2013, Vincent Tobkin became chairman, replacing long-time leader Michael Birck. In our view, these management changes bode well for the future of the company. The company's CFO resigned recently to pursue another opportunity.
If Tellabs resumes revenue growth, its stock will likely rise. TLAB stock is like a non-expiring option play. My firm, CIG, has recommended Tellabs to its research subscribers, and I have subsequently taken long position in Tellabs for my own account. The stock has decent trading volume and liquidity.
We believe, at the current price of $2.17 a share, TLAB is attractive for private investors and for fund managers.
Written by Manoj M. Nadkarni, Principal, CIG. Founded in 1999, CIG offers unbiased, subscription-based investment research on technology companies to affluent investors. CIG has proven track record. CIG disclaims any and all liability in the event any information or opinions prove to be inaccurate or result in any investment or other losses.
Nadkarni owns Tellabs shares.
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The company is scrambling to protect its equities arm, which could face declining volume and revenue as competitors close the gap.
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