Infrastructure
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11/19/2004
03:10 PM
William Schaff
William Schaff
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Taking Stock: Stratex Appears To Be Long-Term Investment

Stratex overestimated the demand for its new Eclipse product.

Product transitions can be immensely disruptive; just look at the results that Stratex Networks is delivering. Stratex designs and sells short-haul wireless equipment meant to transmit telephone and data traffic from remote base stations to an access point on the fixed-line network. The company is the fifth-largest player in this market behind Ericsson, Alcatel, NEC, and Nokia, according to Skylight Research. More than 90% of its sales are derived from outside the United States. Emerging markets are particularly important, with countries such as Nigeria, Russia, and Iraq among its top markets.

Stratex launched its product named Eclipse earlier this year, and revenue from it accounted for more than 18% of net sales during the latest quarter. In my opinion, the problem Stratex faces is that Eclipse supercedes its previous products by rolling the last three main products into one. To make matters worse, the capacity of the new Eclipse product is significantly greater than the previous generation, which means that one piece of new equipment can replace multiple old pieces. And the price of the Eclipse product is lower than that of the previous-generation products!

Stratex suffered during the severe contraction in telecom equipment spending. Revenue collapsed in fiscal 2002 (ending March 31), decreasing 45% from the previous year. Sequential revenue growth returned in September 2003 and continued for five quarters, but this string was broken during the latest quarter. The decline was primarily caused by a steeper-than-expected slide in legacy products; the rapid growth in Eclipse revenue hasn't been enough to offset this downward trend. Meanwhile, gross margins have shrunk from 34.1% in March 2003 to 18.4% in the latest quarter, leading to large losses on the bottom line. That this would lead to cash outflows should surprise no one, but Stratex generated a larger-than-expected negative cash flow. The outflow of $23 million was due partly to the operating losses but, more significantly, inventory of Eclipse equipment rose by $16 million during the quarter. In other words, Stratex overestimated demand for its new product.

There are a couple of brighter spots. Stratex's Eclipse product expands the total addressable market considerably because it includes new functionality. Another positive that may emerge is that once legacy products have shrunk to a small percentage of revenue, the company may post solid growth due to Eclipse. However, Stratex must return to profitability, and sell-side analysts aren't projecting that to occur in the next year and a half.

Is the stock cheap? By some measures, it may appear cheap but not based on profitability. On a price-to-book basis the stock is trading at 1.7 times book, and more than 40% of the total market cap is in cash. However, given the projected losses and negative cash flow, I believe it looks less appealing. The stock may be interesting once the company figures out how to improve profit margins and the growth from Eclipse exceeds the decline from legacy products. However, for current technology investors, in my opinion, a lot of patience and a strong stomach will be required for this stock.

William Schaff is chief investment officer at Bay Isle Financial LLC, which manages the InformationWeek 100 Stock Index. Reach him at william.schaff@bayislefinancial.com. This article is provided for information purposes only and should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any security. Bay Isle has no affiliation with, nor does it receive compensation from, any of the companies mentioned above. Bay Isle's current client portfolios may own publicly traded securities in one or more of these companies at any given time.


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