Wednesday, July 11, 2012

Ixia Still Growing?

In a somewhat mixed week for technology companies Ixia $XXIA beat estimates and raised guidance. I liked what management said about current prospects, and there was some potentially good news coming for Cisco $CSCO stock holders. Its main rival is the UK’s Spirent although, Agilent also has exposure to this sector through its communications testing division.

Ixia and its main rival Spirent, represent the two best 'pure plays' to benefit from the roll out of next generation wireless technologies. These companies primary activities are to stress test the load bearing capacity of telecommunications network equipment manufacturers and large service providers.

In particular, both stocks are exposed to the upgrade cycle in 4G ad LTE spending, which should see them both expanding margins and cash flow as their customers appear to be in the early stages of a sustained capital expenditure cycle. I previously mentioned Ixia in a post on smart phones linked here, and, I will focus on the US company.

The case for Ixia is relatively simple. From the consumer side, there is an explosion in bandwidth demand which is being driven by social applications (facebook, twitter etc) and a concomitant technological revolution in smart phones and internet based devices.

On the business side, there is a huge increase in demand for ‘anytime, anywhere’ internet access utilizing increasing usage of data. Furthermore, the service providers are moving beyond purely providing bandwidth, by increasingly selling cloud services and helping large enterprises to outsource their IT. All of which, is placing increasing demands on Ixia’s end customers, and it is inevitable that an upgrade cycle will follow.

In addition, as internet traffic grows more complex, there is an increasing demand for large enterprises (financials etc) to invest in stress testing equipment. Financials are seen as a key growth market because their end demand is mission critical and, quite frequently, involves dealing with unusual patterns in network usage.

Ixia Q1 Results

A quick look at the earnings and guidance show an earnings beat plus a hike in guidance
  • Q1 Revenues of $85.6m vs. estimates of $83.5m
  • Q1 Non-GAAP EPS of 15c vs. estimates of 14c
  • Q2 Revenue guidance of $86-89m vs. estimates of $87.09m
  • Q2 Non-GAAP EPS guidance of 15-17c vs. estimates of 15c
Cisco is Ixia’s biggest single customer and its orders managed to contribute 17% to revenues after having dipped below 10% last year. Cisco is obviously doing something right, as orders came in above Ixia’s expectations. Cisco spoke of weakness in Government orders last year, but now Ixia is reporting that they are seeing more orders from the US Federal Government and elsewhere in the world. In addition, support revenue from Cisco is now due in Q2 instead of being in its traditional place in the Q1 numbers. It all augers well for Cisco's core networking market.

The other top non-distributors are NTT, Dell, Juniper, and Fujitsu. Details on Juniper's orders were not given, but it is reasonable to assume they were solid.

Turning to the breakdown of customers by type.

Customer Type Percentage of Revenue
Network Operators 58%
Service Providers 20%
Distributors 14%
Enterprise/University/Government 8%
From a geographical perspective, Japan was the star of the quarter. LTE and Wi-Fi orders being cited as particularly strong. However, Ixia guided gross margins sequentially lower (78-90%) in Q2 because, Q1 saw high margins due to Japanese revenues containing a larger part of software in the sales mix in Q1.

In a sense, much of this was presaged by Spirent’s preliminary results given on the 1st of March and, also by Agilent who said this in a recent analyst day
“But again, the good news, as we stand here, is that the February orders were solid for the start of our Q2. In the area of Communications, we believe the Communications growth in the quarter year-over-year will grow”
The whole industry looks strong.

Ixia’s Growth Drivers

Wireless orders were at a record, with strong new 3G purchases coming from Asia. Whilst wireless attracts most attention due to its greater growth rates, it should be emphasized that this produces a backload which is then dealt with by wire line. In other words, both these markets will see sustained growth as a consequence.

Ixia also offers the prospect of strong growth in Ethernet based infrastructure. Within data centers, the increases in bandwidth and data demand, have dramatically increased the speeds that the centers need to work with. Ixia stated that some data centers are investing in 100G speeds, with 40G seen as the preferred speed. Wheras, so long ago, 10G infrastructure was seen as the gold standard.
Summarizing the key market drivers and trends.
  • Smart Phone penetration growth rates
  • Mobile broadband growth
  • Network traffic growth
  • 4G/LTE growth plus 3G roll out in less advanced countries
  • Mobile subscribers growth in the BRICs
All of which are attractive, as is Ixia’s ‘growth at reasonable price’ proposition.

Even assuming a more ‘normalized’ tax rate of, say 30%, would put the stock on a near 5% free cash flow yield. Throw in analyst's forecasts of mid teens annualized growth in revenues and earnings, for the next couple of years and, Ixia’s evaluation of 13.6x EV/EBITDA does not look expensive.

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