InformationWeek

October 20, 1997

Taking Stock: Bay Networks Bounces Back

Networking vendor's stock is on the rise once again, thanks to new products and a reorganized management team

f you had owned Bay Networks stock over the past year and a half, you'd have had to have been either a value investor or a masochist. The stock declined from a peak of $49 in 1ate 1995 to a low of $15 in March 1996. Since then, it has steadily climbed back to its current level of around $35-but not without a few bumps and bruises along the way.

Bay Networks is a well-known corporate name. It's usually associated with the development, manufacture, and marketing of data networking products, including routers, hubs, switches, and network-management software. Most IS managers are familiar with Bay's products and services, which have always had a reputation for relia bility.

Unfortunately, in recent years, Bay became noncompetitive technologically. The company was slow to react to the shift away from its core hub-and-routing business to switching. But fortunately for investors and IS managers alike, the networking landscape is rarely stable, and much has changed in 1997.

New-product flow is what usually helps support a rising share price. In Bay Networks' case, the company finally seems to be running on all cylinders again and producing many new products at competitive prices.

Revenue for the most recent quarter reflected the strong demand for Bay's new offerings. More than 45% of the latest quarter's total sales were from new products. Switching products, which now represent about 31% of total sales-up from 19% last year-have grown 35% since 1996. The growth in switching products was led by the BayStack product line, specifically Bay's 350T switching hub.

Forthcoming product releases from Bay include Gigabit Ethernet switches and products related to the Layer 3 switching technology obtained in its recent acquisition of Rapid City Communications. Bay's Shared Media intelligent hub and routing business will slowly decline, only to be replaced by its more-profitable switching products.

But before anyone writes off hubs and routers too quickly, a fast analysis of the most recent quarter's numbers shows that these lines are far from dead.

In fact, several new modules should help extend the shelf life of Bay's intelligent hub business. The new Route Switch Processor, a 1.5 million-packet-per-second IP router on a chip due in early 1998, will enhance the company's router business.

In addition, Bay introduced the Accelar line, a hybrid router-switch priced less than a router and slightly more than a traditional Layer 2 switch. The company also expects to ship in volume its high-density, carrier-class remote-access concentrators during the coming quarter. IS managers have responded to both the quality and pricing of Bay's new product releases with renewed enthusiasm.

Credit Where It's Due
Part of the success story is the turnaround in the management team, led by David House. Not only has House refocused management on competitive product development, but he's also strengthened management in research and development, marketing, and finance. The recent reorganization has led to stronger sales and marketing focus, reduced sales costs, and higher product profitability.

Bay Networks just reported financial results for its fiscal first quarter. It posted revenue of $601 million, up 15% over the same quarter last year. While operating margins in fiscal 1997 were barely above 6%, lagging behind competitors by as much as 20%, operating margins for the most recent quarter improved to 11%. The most recent earnings per share were 22 cents. Gross margins were at 51%, with a stated company target of 55%.

I project that with the introduction of new products and a substantial increase in sales, operating leverage will boost 1998 earnings per share.

William Schaff is c hief investment officer at Bay Isle Financial Corp. in San Francisco, which manages the InformationWeek 100 list. Reach him at bschaff@bayisle.com .

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