Taking Stock: Innovation Loses Out To Low Prices

Wasn't it just a few years ago that leading-edge technology translated into a high premium on share price? After all, who would want a company that made standardized products with no barriers to entry by well-funded startups?

Sadly, how the world has changed for technology companies and technology investors. Just look at the fortunes of Computer Network Technologies, a provider of comprehensive storage-networking products. An early warning of weak earnings coming for its second quarter, ending July, didn't help. This was on top of weaker-than-expected revenue in its fiscal first quarter.

What happened? Computer Network Technologies has always been innovative in providing leading-edge storage-area-network and WAN products. Its leading high-end extension products include UltraNet Storage Director, a multiprotocol switching platform that connects host-to-storage and storage-to-storage systems across large companies. Big customers such as EMC and IBM have enjoyed the benefits of its technology. Customers benefit from reduced administration costs and a higher level of reliability. In addition, Computer Network Technologies is emphasizing its managed services offering, which includes products, consulting, and design.

However, what used to be a mostly proprietary market has become dominated by standards-based products--at much lower prices. Even the company's high-end Director switch platform will be met head-on by competitors' lower-priced products. Also, as the company moves more into managed services, it may end up in conflict with some of its former business partners. And don't discount the competition in this market, since it's made up of well-funded companies such as Brocade, Cisco Systems, and McData.

Management came out with revenue guidance of $75 million to $80 million for the second quarter, resulting in an estimated 19 cent to 23 cent loss per share. Revenue is down significantly from the $96.2 million last quarter and the $96.7 million in the year-ago quarter. The company also anticipates additional restructuring charges and layoffs of 15% to 20% of the workforce. Wall Street consensus earnings estimate for the fiscal year ending January 2005 is 16 cents per share, but with the recent warning, it's likely to be in the red for the full fiscal year.

Wall Street expects that the company will make a profit of 36 cents per share in fiscal 2006 but, again, I believe that figure is likely to come down in light of the recent earnings news. It wouldn't surprise me to see the fiscal 2006 earnings per share closer to 20 cents to 25 cents. The other consideration is that the balance sheet should continue to decline as cash is consumed in operations. Assuming company sales stay low for the balance of the year, resulting in estimated sales of $330 million, the stock is selling at 0.2 times sales and 0.95 times book value.

William Schaff is chief investment officer at Bay Isle Financial LLC, which manages the InformationWeek 100 Stock Index. Reach him at [email protected]. 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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