Tech investors and analysts can be fickle creatures - they'll happily project astonishing revenue growth and breathtaking forward multiples when times are good, but they'll turn quickly when growth lags and often over-correct to the downside. None of this is to say that Acme Packet (Nasdaq:APKT) is automatically undervalued, but it may be worth asking whether circumstances have changed so much in the past half-year that the stock should only be worth half of what analysts once said it was worth. Can Acme Packet Keep Its Share?
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Weak Carrier Spending Still the Story
Ongoing weakness in carrier spending has been the dominant theme this year for a host of equipment and component suppliers ranging from Alcatel-Lucent (NYSE:ALU) to Ciena (Nasdaq:CIEN) to Juniper (NYSE:JNPR) and so on. With about 80% of its revenue coming from service providers such as Verizon (NYSE:VZ) and AT&T (NYSE:T), that's clearly a proximate cause of Acme Packet's disappointing performance this year.
Carrier spending still looks like a "when, not if" question, but that question of when is really weighing on these stocks. Verizon and AT&T have been reporting good wireless margins and low churn, but it seems like the companies are incrementally more interested in spending cash on spectrum and share buybacks than gear. While this can't go on forever, it likely can go on long enough to make things difficult for many of these equipment vendors.
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Another of the concerns regarding Acme Packet is whether the company can maintain its leading market share in session border controllers. Although I wouldn't just dismiss the threat of Sonus Networks (Nasdaq:SONS), Juniper or Cisco (Nasdaq:CSCO), companies such as F5 (Nasdaq:FFIV) and Riverbed (Nasdaq:RVBD) suggest that maintaining market share in growing hardware markets isn't as impossible as bears like to suggest.
Not only does Acme Packet have a broad customer base, it has a wide array of products to address those customers' needs. To that end, guidance from management suggests that the company's win rate is still in the 90% range. It's also worth noting that there's still growth potential from markets like Voice over LTE, IP media subsystems and SIP trunking.
No Good News Today
Tech stocks work on sales momentum, and that's decidedly lacking from the Acme Packet story right now. Not only did the company take down guidance pretty substantially after the last quarter, but there's been very little positive news of late from other players in the carrier spending environment.
It's looking less and less likely that there's going to be a second-half spending recovery, as carriers seem increasingly nervous about the macro environment. Along those lines, Voice over LTE may be more of a 2014 development, and while the SIP trunking market (which is an enterprise market) is growing, it's growing slower than management initially hoped.
The Bottom Line
In about six months, sell-side analysts have cut their fair value estimate on Acme Packet by almost 50% and their 2013 revenue estimates by roughly one-third. That's a startling revision given that I don't believe the full-cycle opportunity has declined that much.
However, that's also not to say that this is an easy stock to buy today. With revenue estimates for 2013 having dropped by roughly one-third, the question is whether the estimates for 2016/2017 revenue (which were in the neighborhood of $600 million to $700 million) were excessively high to begin with, or whether Acme Packet is going to see a big improvement in growth after 2013.
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If you believe that the company will produce low-to-mid teens revenue growth and gradual improvement in free cash flow margin into the high teens, the stock is more or less fairly valued today. Maintain the same long-term revenue estimate as before, though, and you see revenue growth in the 20% range and a fair value into the mid $20s. As a result, investors considering this name should realize that its stock is likely to be exceptionally volatile, as analysts and institutions look for any incremental information about major carrier spending plans.
At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.
Can Acme Packet Keep Its Share?