Three "Overlooked"
Tech Stocks With
Major Upside Potential
by Yale Hirsch, editor
Smart Money
Free
computers, free e-mail, free Internet accesswhat does it all mean? People
are giving computers away to users who are willing to endure continual advertisements
on the screen. You can also get a free or very cheap computer if you subscribe
for Internet service. Conversely, some computer retailers are offering free
net service for a certain period with the purchase of a computer.
Now
Alta Vista (currently a subsidiary of Compaq) has plans to offer totally
free Internet connections forever. The only catch, apparently, is that subscribers
will be subjected to adsbut that's the case with paid service as well. Alta
Vista will be the first large-scale free Internet service provider (ISP)
in the U.S., but the trend has already taken hold in Europe.
Eyeballs
are valuableand becoming more so. Talking to people in the Web content business,
we find that advertising revenues in some cases are exceeding expectations.
The doubts about whether advertising could support Web enterprises are being
answered, though we doubt that advertising will bail out all the hundreds
of Web sites being launched.
The
upshot? Be wary about investing in PC or ISP companiesunless they have something
very special going for them. Even Intel is feeling the pressure as demand
soars for low-priced computers (run by low-priced processors). But that
company is smart and flexible, proving recently its ability to make money
on the low end and even more on the high end (chips for the servers that
spew out content on the Internet).
If
cheap or free computers and ISPs spell trouble for some firms, they also
mean the Internet will continue to expand at its frantic pace. A new user
gets on board the Net every five seconds. That means exploding demand for
all the equipment and software that runs the Internet.
For
years we have been saying that the best and safest way to invest in the
information and telecommunications revolution is through infrastructure
companies. While there is plenty of competition in the equipment field,
the barriers to entry are highquite unlike the case for ISPs and content
providers. What's more, the best companies tend to achieve very high gross
margins, despite the competition.
The
current market is dramatically confirming our point of view. Amid the recent
onslaught of new issues were many losersstocks that went down almost immediately
after release. That's unusual and points to a market temporarily sated with
Internet stocks, as well as some lax or greedy underwriting. Most of these
soggy IPOs were content providers and e-commerce ventures.
The
hardware and software offerings found a better reception, and the best of
these have soared to amazing heights, despite a market in the doldrums.
Juniper (JNPR), Redback (RBAC), and Red Hat (RHAT) reached heights around
six times their offering prices and remain not far from those highs. These
are perhaps the two best of the recent crop of communications hardware firms
plus a unique software outfit. Red Hat is the leading firm specializing
in Linux, the robust "open" operating system that is finding favor
with Web firms.
We'd
like to own these stocks, but not at current prices. Instead, we have put
together some alternatives-stocks that are cheaper, though not necessarily
cheap. We hope to buy them lower. At this writing, tech stocks are recovering
from their correction, but we are heading into a seasonally rough time for
tech issues and we don't think the gyrations are over.
The
market's direction is also more uncertain than usual. This is a good time
to hedge your bets, doing some buying on a scale down. If stocks run up
instead, some profit taking is in order, given high valuations and a dubious
monetary outlook. Either way, you should have some buying power available
for possible renewed opportunities during the next three months.
Concentric
Network Corp. (Nasdaq CNCX 23-7/8. Buy limit $19) is an Internet service provider,
but one with a major difference. The company concentrates on high value-added
business applications, not the consumer market where we expect increased
competition. With its own technology and network (emphasizing high-speed
connections), Concentric has put together an impressive, if rather short
growth record, and is in a position to continue that pattern.
The
company was founded in 1991 and began the operation of its own network in
late 1994. From very low numbers four years ago, sales reached $63.1 million
in the six months ended June (up 75%).
The
gains were bolstered by acquisitions, including Internex, a provider of
network services, collocation services, and Web hosting facilities. Also
bought were DeltaNet (dial-up and dedicated access services, Web hosting
and Web application and design) and AnaServe (Web hosting services).
The
design apparent here is that Concentric wants to be a full-service provider
of everything companies needfor communications or an e-business presence.
It makes perfect sense: The market for value-added IP (Internet Protocol)
data networking services is expected to expand from $2 billion recently
to $27 billion in 2002 Like last month's recommendation Level 3, Concentric
is concentrating on IP-based systems.
The
company is focused on virtual private networks, expected to be a big growth
area, and Web hosting, already a source of major growth. Many companies
today use wide area networks (WANS) for data and voice communications between
company facilities and key customers and suppliers. These are highly efficient,
but expensive, if they employ dedicated lines.
The
same thing can be accomplished much cheaper over the Internet, but that
adds security and latency (slowness) problems. Sophisticated software, plus
combining some private facilities with the public network can solve most
of these problems. This can also make outside access to the network easier,
which is important as more and more employees are telecommuting.
The
enormous growth of the Internet has prompted an almost insatiable demand
for Web hosting services. Even fairly large providers of Internet content
and services don't want to maintain their own sites, which involves having
redundant equipment, phone and power supplies, plus having technical people
available around the clock. So they are turning to companies like Concentric
that can provide the most advanced facilities and hosting service.
Customers
and partners include some of the major telecom, Internet and technology
companies, indicating Concentric's reputation in the industry.
Intuit's
Quicken, TurboTax, ProTax and other programs are leaders in personal and
small business financial software. The company chose Concentric for Internet
access to the Quicken Financial Network and a Concentric VPN for selected
Intuit Web sites.
WebTV
Networks, the leading Internet solution for television, partnered with Concentric
to design and implement a national VPN to connect users to the Internet.
Internet TV has not yet been the blockbuster some expected, but this, or
products deriving from it, still have a good chance of being important.
There are other deals, including an arrangement with PictureTel and with
OnCommand, a provider of in-room TV services for hotels.
Having
established itself as a leading business ISP and Web host, Concentric is
broadening its reach by providing service to home-based businesses and residential
customers. Prices for high-speed DSL access start fairly low ($69 a month),
a modest premium to what the Baby Bells are charging for the residential
DSL service they have just started to roll out.
The
company's intent is to get a premium price for premium service (it has won
awards for the quality of its service). The Concentric package includes
Web hosting for establishing a business site, five e-mail boxes and support
for a local network of up to four computers. Launched a year and a half
ago, the service is available in most of the nation's large cities.
Concentric
is losing money and probably will be for another two years or more. The
idea is to grab market share, which requires spending money on equipment
and marketing. There's substantial debt and preferred stock on the books,
but also plenty of cash. Current assets of $344 million are enough to carry
the company quite a while. The stock is selling at half the earlier high.
Contact:
Henry R. Nothhaft, President, Concentric Network, 1400 Parkmoor Ave., San
Jose, CA 95126, (408) 817-2810, www.concentric.net.
Loral Space & Communications (NYSE
LOR 18-7/16. Buy limit $16-3/4) provides representation in one area of telecommunications
where our portfolio has been lackingsatellites. This is a fairly big company
so we can't expect growth like we are getting from some of our small-cap
recommendations. But you have to be big to participate in the space business,
and it should be a very interesting field during the next few years.
Satellite
stocks have been depressed because of the failure of Iridium, the first
outfit to offer what was supposed to be universal global telephone service
through a satellite system. But now the other stocks are recovering and
apparently there will be one less effective competitor.
Iridium's
system was too expensive and it just didn't work very well. According to
the experts, the design of the coming satellite phone systems will allow
service to be sold much cheaper and the phones will work better. Loral participates
through its 43% interest in Globalstar, and it has substantial additional
interests in space technology.
Loral
was formed three years ago when Lockheed Martin spun off its satellite operation.
(Lockheed retains 14%). The main business was manufacturing satellites,
but Loral has since broadened its operations by acquiring important interests
in communications systems.
Besides
Globalstar, there is CyberStar, a potential carrier of wireless multimedia
transmissions; Europe*Star, a new joint venture with Alcatel; and Skynet
(Telstar). The latter, purchased from AT&T, is enjoying 40% annual growth
carrying TV signals for some of the major broadcasters. That growth should
continue as Skynet expands coverage to Latin America, Russia and the Middle
East.
We're
old enough to remember that people thought satellites were going to be a
growth industry 30 years ago. Sometimes things take longer than expected;
the best still lies ahead for this industry. While the lacing of the U.S.
with fiber optic cable has limited one market for satellite communications,
satellites are more important than ever in filling gaps. For example, they
will provide broadband service to areas too thinly populated for fiber to
be laid. They are already being used for the upload phase of broadband Internet
service, as this is sometimes cheaper. And the use of satellites for broadcasting
(both direct broadcast and as links) is expanding rapidly.
But
untapped markets offer even more potential. More than half of the world's
population has never made a phone call. In China alone, there are half a
million villages with no telephone service whatever. Surprisingly, even
in the U.S., cell phone coverage extends to less than 20% of the territory.
In
just a few months, the next worldwide wireless telephone service will be
launchedGlobalstar, with important partners such as Vodafone and China Telecom
in addition to Loral. In contrast to all other systems so far, Globalstar
uses low orbit satellites. This reduces transmission time and hence costs.
put another way, it increases the bandwidth of the system. Radio waves travel
very fast. Still, when you are sending a lot of data thousands of miles
into space and bouncing it back, the distance factor is important.
George
Gilder (Gilder Technology Report 888-647-7304) has thoroughly studied
Globalstar and concluded that its technological advantages are overwhelming.
He believes the partnership will begin by charging 35 cents a minute for
wholesale links, with retail charges about a dollar a minute. That's high,
but a lot cheaper than Iridium, and prices should come down over time.
Gilder
projects that the system can break even with 400,000 subscribers while it
can handle 4 million. Adding additional satellites will bring on more capacity.
Some other analysts are looking for as many as 35 million customers in the
fairly near term. That seems high for now, but it could be just the beginning
if Globalstar becomes the dominant telephone service in much of the third
world. And that would mean huge profits,
There
may be more potential in the stock of Globalstar (GSTRF) itself. But there's
also more risk. Loral has a major stake, but also some other good businesses
(with $2.1 billion backlog). In the June quarter, operating revenues rose
52% to $378 million. Operating income rose strongly and the company had
positive cash flow, but high development costs swallowed most of the potential
income.
After
declining, LOR has been in a trading range since late last year. The bottom
of this range should be a safe buying are.
Contact:
Bernard L. Schwartz, Chairman, Loral Space & Communications, 600 Third
Ave., New York, NY 10016, (212) 697-1105, www.loral.com.
Unify
Corp. (Nasdaq UNFY 13-5/16) is an issue we have been watching for a long
time. it ran up while we were analyzing it late last year, and ever since
we have wished it would pull back so we could recommend it.
Now
we find that a competitor has just gone public and immediately doubled in
price despite the mostly lackluster IPO market. This company, SilverStream
Software (SSSW), is comparable to Unifyexcept that it suddenly has a market
cap five times as large, despite substantially smaller sales and big losses.
By contract, Unify turned in an impressive July fiscal quarter with earnings
of 18 cents a share (fully diluted) versus 3 cents.
Despite
the earlier price advance, Unify looks way undervalued compared with what
is coming down the pike. It has been in a narrow range most of the year,
and still is largely undiscovered. UNFY looks like a decent buy here and
a great buy on a moderate dip.
While
SilverStream has experienced management, it is just three years old, while
Unify is a veteran of 20 years in the software trenches. The company has
always had good technology but found it hard to gain ground against the
giant software companies. However, management sensed the importance of the
Internet and redesigned its product line to fill the needs of e-commerce
firms. That has turned the company around and promises substantial growth
as far as the eye can see.
Putting It All Together
The
company's main strength is the ability of its software to integrate legacy,
custom-built and packaged applications with the Internet. The nation's total
e-commerce revenues are already approaching a rate of $100 billion a year.
Projections are that this figure will climb more than 10-fold within the
next two or three years.
Hundreds
of new enterprises have been created to take advantage of this trend. Less
noticed is that most traditional companies are scrambling to establish an
Internet presence to retain their market share and try to grab a piece of
the newly baked pie.
Gearing
up for Internet commerce is hard enough in itself. Most older companies
also have legacy software for inventory, customer data bases, manufacturing
data, sales contracts and so on that must be integrated with the e-commerce
system to make the business run right. This software may be from several
sources and written in different languages. The beauty of Unify's product
line is that it can integrate most of this old software with a new e-commerce
solution.
Products
include the VISION AppServer and AppBuilder. Application servers are vital
software products that sit at the heart of a system and make it all work.
Unify's servers work with Windows and HTML browsers as well as newer Java-based
software. They are "dynamically scaleable," meaning that Unify's
unique architecture allows software to be changed or capacity to be expanded
at every level of the system.
Customers
and development partners include some of the biggest names in technology
and among the Fortune 500. The company's specialty is software for large
businesseswhich is where the big bucks are. Unify will have a Windows 2000
version of its VISION product ready as soon as Microsoft introduces its
new operating system.
Today
some people are excited about Linux, the increasingly popular "open"
operating system. Unify is working with Red Hat Software, the hot new company
advocating this hot new software, to expand offerings for Linux solutions.
The company soon will have launched no less than seven solutions for Red
Hat Linux 5.2, the latest version of the system.
Solid Financials
For
the fiscal quarter ended July 31, Unify reported sales of $8.7 million,
up 31%. More important, revenues from Internet product license fees were
$3.8 million, a 78% increase. Sales come from services and software maintenance,
development licenses, and deploying licenses (a continuing revenue stream
based on the number of concurrent users at a customer firm).
The
18 cents in quarterly earnings per share came on 13% more fully diluted
shares outstanding. (But the market cap is still low compared to other Internet
plays of comparable quality.) The balance sheet is in good shape, with no
debt outstanding.
Contact:
Reza Mikailli, President, Unify Corporation, 100 Century Center Ct., Ste.
302, San Jose, CA 95112, (408) 451-2000, www.unify.com.
Editor's Note: Yale
Hirsch is editor of Smart Money, now in its 27th year of publishing,
P.O. Box 2069, 184 Central Ave., Old Tappan, NJ 07675. Monthly, 1 year,
$120. Visit the Web site at www.HirschOrganization.com.
