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Buying the Best and Brightest at Fire Sale Prices
Sifting through the ashes for tech bargains
by Briton Ryle
It’s hard to find the silver lining of the dark cloud that’s hung over tech stocks for the last year. But it’s there.
Many of the market leaders in wireless and fiber optics are now trading at reasonable, if not downright cheap prices. There hasn’t been a better opportunity to pick up blue-chip techs in recent memory.
I recently started running some stock screens to see what kind of bargains are out there. I wanted to find companies with a lot of cash, low price to book and forward sales ratios, low debt, strong revenue growth, and a dominant market position.
I found some pretty interesting companies, including JDS Uniphase and Qwest. But the one I like best has nearly a billion dollars in the bank, almost no debt, is on track to more than double 2000 revenues, and trades at a 50% discount to book value and around 6x 2001 revenues. And it’s absolutely the 800-lb. gorilla in its space.
Any guesses?
The envelope, please
OK, I’m talking about Aether Systems (AETH:NASDAQ). I believe Aether has one of the best risk to reward profiles in technology today. Aether has recently been rocked by an orgy of downgrades. But, as I’ll discuss later, the basis for the negative outlook is actually a long-term positive.
First, let me show you why Aether is the dominant company in the wireless data application market.
Aether was founded in 1996. Its first products were financial services geared toward the institutional trader market. Early adopters were Morgan Stanley, Bear Stearns and Charles Schwab.
The company has since branched out into the education and medical fields. Financial services now make up only around 20% of sales. Aether’s using a partnership-oriented marketing strategy, where companies like Sylvan Learning Centers and Parkstone Medical help it sell its products to companies in their respective fields.
Other important partners include Hewlett-Packard, Palm, Reuters, Visa, Openwave, Certicom and Research In Motion.
Aether’s also entered the transportation market through an acquisition from Motient (MTNT:NASDAQ). Revenues from this area have not really kicked in, as this is a recent acquisition.
Aether currently has 23,000 people subscribing to one of its data applications, with an average monthly revenue per user of US$132. Subscriber fees currently make up about half of revenues
Who you gonna call?
What makes Aether’s products so compelling to the corporate market is the comprehensive nature of its offerings. For the average company, wirelessly enabling its workforce is no small matter.
First, you have to create the application, which requires specialized software developers. Then you need to hire IT staff to support the application. You’ll need a data center to host it, and, finally, you’ll need to negotiate airtime with wireless carriers.
Or you could call Aether Systems. Aether’s got the software developers and the IT staff. It hosts corporate websites for wireless access for US$10,000 a month, and it’s got deals with the major wireless carriers, not to mention its 25% stake in Omnisky.
All data, all the time
It’s easy to see why the trend is toward outsourcing wireless data applications. And Aether’s versatile product mix has led to an amazingly diverse customer list, including E*Trade, Office Depot, the U.S. Navy, the U.S. Post Office and the city of Seattle. I’ve included a more complete customer list at the end of this article.
The market for complete wireless solutions is growing like wildfire. If you ever have any doubts about the size of the market for wireless voice and data, you should check out the research done by Cahner’s In-stat (www.instat.com). A quick perusal of this website can be a real eye opener. One of my favorite tidbits concerns the growth of wireless data subscribers. Cahner’s sees global subscriber numbers growing from 174 million now to over 1.3 billion by 2004.
Of course, good technology and a huge market are no guarantees of success. And the market has certainly changed its expectation of Aether, taking the stock from a frothy US$345 a share to under US$30. To add insult to injury, the stock’s been nearly cut in half over the last five days. This latest selloff bears a little more examination, because I believe the market is overreacting to Aether’s latest earnings report and forecast.
Revenue explosion
First, there’s the good news. Aether’s fourth-quarter numbers crushed analyst estimates, posting a US$0.90 cent loss against estimates of US$1.00. Also, 4Q revenues came in at US$25.8 million, a 59% sequential gain over 3Q revenues and around 40% over estimates. Fiscal 2000 revenues hit US$58.2 million, up from just US$6.3 million in fiscal 1999.
The company also made some pretty bold forecasts for the next couple of years. Aether raised revenue estimates to US$180 million for 2001 and US$350 million for 2002. On top of three consecutive years of triple-digit revenue growth, Aether believes earnings will be EBITDA positive by 3Q 2002, a full year earlier than expected.
Aether’s impressive 4Q results were all the more impressive considering that most tech companies revised revenues downward due to slowing demand. But after trading higher in the after-hours session following the earnings announcement, the stock’s been absolutely crushed. So what happened? Why’s the stock getting hammered in the face of such good news?
Too good to be true?
Three words—lock-up, loss, margins. Aether has 18 million shares coming out of lock-up periods over the next month. I don’t believe this is a significant event in and of itself. It will, however, keep buyers at bay over the next few weeks, which means there will be little price support as sellers fret over the other two factors.
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Aether Systems Customers List |
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Financial |
Transportation Supply Management |
Field Sales/
Service |
Healthcare |
Other Industries |
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Bear Stearns
Charles Schwab
Cyberbills
Goldman Sachs
Foreign Exchange
Merrill Lynch
Morgan Stanley
National Discount
Reuters
TD Waterhouse |
Ferguson Enterprises
MAC Papers
MCI
(VANS Group)
NuCo2
Office Depot
Physician Sales & Service
Response Services
Suntory Water Group
Supply Line
U.S. Postal Service
WebVan |
AC Nielson
Coca-Cola
Extensity
Oracle
Papel Giftware
Proctor & Gamble
Security Source
Siebel Systems
Sony |
Becton Dickenson
Wake Forest University
Medtronic
Sonic Innovations |
GTE
U.S. Department of Defense
Northrup Grumman
NowSpeed
AT&T
Spyglass
MCI/Worldcom |
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Source: Epoch Partners |
Some concern was raised over the erosion of Aether’s gross subscriber margins, which dropped from 50% in Q3 to 32% in Q4. The reason for this is twofold, though they both concern Aether’s relationship with Research in Motion. Aether’s been re-selling BlackBerry (RIM’s very popular PDA) as a marketing tool, and the margins on the hardware have a negative effect on subscriber margins as a whole.
Also, Aether’s been paying RIM on a monthly basis for hosting services. That’s about to change, as Aether will take over the hosting duties in the near future.
How to spend a billion dollars
That leaves us with one negative catalyst, and it’s a big one. Aether expects to lose nearly twice as much money in 2002 as had been expected. And 2001 loss per share has been revised upward as well.
Aether says it will increase spending to take advantage of market opportunities. By my calculations, Aether will burn through the rest of its considerable cash position over the next two and a half years.
You can look at the increase in loss as good or bad. Approximately half the loss will be depreciation and amortization related to acquisitions. The rest can be considered an investment in the company’s future. These are not necessarily bad things.
But nothing conveys stability to potential customers like a fat bank account. Cash to cover operating expenses is like an insurance policy that Aether will be around to fulfill its service obligations. On the other hand, no one is better positioned in the wireless data space, and I doubt Aether would have any trouble raising money if it needed to.
Without raising any more cash or diluting its stock, Aether should be able to build a profitable business and incur only US$300 million in debt. That’s pretty good. Aether’s got its business strategy together. Now it’s time for us to get our investment strategy together.
Timing an entry
The first, and largest, lock-up expiration is February 24, about two weeks away. It’s expected that only 6 million shares will actually be sold. Funny thing about lock-ups, the anticipation is usually worse than the actual event. Stocks tend to bottom before the expiration date and rally afterwards.
Based on market conditions in general, and the negative sentiment toward Aether in particular, I think there’s a very good chance this stock will hit the teens before the 24th of this month. If Aether goes below US$20 between now and the 24th, I recommend taking a position.
A share price of US$20 implies a market cap of about US$780 million. At that valuation, Aether would be trading at 4x 2001 sales. I have a hard time imagining a company with triple-digit revenue growth trading at 4x sales, but I’ve been surprised more than once over the last few months.
I imagine, at US$20 a share, we’ll see a bunch of analysts who downgraded Aether come out and say something like, "Despite our concerns about Aether’s future, the current valuation is an attractive entry point." Won’t it be nice to have just taken a position when the analysts decide they’ve overdone things just a bit?
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