Saturday, September 22, 2012

Acme Packet Has Upside Potential

So why would Acme Packet $APKT be the next Riverbed Technology $RVBD and what exactly does that mean anyway?  Well, what I am referring to is the fact that Acme is faced with the same sort of investment quandary that Riverbed was faced with recently but for different reasons.

Both companies are seeing a weaker operating environment and both stocks had reported weak results. In both cases, some analysts were quick to conclude that there was some structural problem. In Riverbed’s case the WAN Optimization market was supposed to be saturated and growth would therefore slow dramatically. It didn’t turn out to be the case and the stock soared.  With Acme Packet, the core market of session border controllers (SBC) is possibly structurally challenged.  In the light of the recent results from Sonus Networks $SONS I thought it would be interesting to take a closer look.

Session Border Controllers Versus End to End Solutions

SBCs are networking equipment that control real-time session traffic at the signaling and call-control as they cross a packet-to-packet network border between networks or even between different portions of a network. Essentially they are a play on the convergence of voice and data networking, otherwise known as Voice over Internet Protocol (VoIP).  SBCs are necessary because they allow for session traffic to cross network address translation devices or firewall boundaries in real time.

The issue clouding the outlook is that Acme's core market of Session Border Controllers (SBC) may well be challenged by other vendors selling end-to-end integrated solutions to network management.  SBCs control signaling between service providers and when they (service providers) purchase end-to-end solutions, they can be seen as competing for network spending dollars, particularly when the end-to-end solution has SBC capability already built into it. For example a company like Ericsson can come along and offer an integrated solution which obviates the need for an independent SBC from Acme Packet or Sonus Networks.


So What Did Sonus Networks Say?

Sonus said two things.

The first is to reiterate what everybody should know by now. It is a weak capital spending environment for the service providers. I have discussed this issue in an article linked here. With regards the big two in North America, AT&T $T i saying they intend to spend more in the second half but this deserves some circumspection whilst Verizon $VZ is intending to reduce capital expenditures as a share of revenues. In fact Verizon has gradually lowered expectations for capital spending throughout 2012. There is a sense that Verizon has already spent significant sums on rolling out a network in previous years. Therefore it was no surprise when Sonus declared that only one customer accounted for more than 10% of revenues and that –of course- was AT&T.

The second thing was far more interesting. Trunking product revenue declines were guided even lower but, in essence, there is nothing wrong with the SBC market! In fact, Sonus claimed to be taking market share and made very confident growth noises. It claimed its SBC revenue was stronger than had been expected and forecast that by year-end SBC would make up 50% of its revenues.

With guidance that management described as being ‘conservative,’ Sonus predicted third quarter SBC revenue of $17-19 million and a significant increase in the fourth quarter to $22-25 million. The full year outlook was consistent with prior expectations. In other words no SBC slow down here.

What This Means to Acme Packet

The obvious inference is that Sonus is taking market share from Acme Packet and this may be the case. However, we mustn’t lose sight of the fact that Sonus was very positive about the overall SBC market. It may well turn out to be a sweet spot within telco spending and the long term story remains valid. The fears over a slowing in SBC growth due to end-to-end solutions grabbing their marketplace seem unfounded.

For Acme Packet this implies that its core end-market may not be as tough as we may have thought it to be. Perhaps the previous earnings miss really was a case of management being too optimistic in its guidance and maybe not factoring in the strong competition from Sonus which was fighting hard to make up for trunking product weakness. If so, Acme has the potential to come back just in the same way that Riverbed did when it announced results.

It is a tempting idea but there is a slight flaw. Riverbed was cheap on a cash flow evaluation basis before it reported while Acme Packet is not cheap by any measure that I care to consider. However, evaluations are, more often that not, subject to the conscience of the individual investor. So for those comfortable with Acme Packet at these levels, there could be a decent case for an entry point here.