Sunday, August 26, 2012

A Look Back At Acme Packet's Results

Acme Packet $APKT delivered the kind of warning that many tech investors are worried about in the forthcoming earnings season. Make no mistake, this was a significant reduction in guidance and it sent the rest of the sector scrambling to sell stock in sympathy. As ever, investors need to ask themselves whether this is a clear sign of a rapidly deteriorating environment or a company-specific issue?  In summary, I think it is more a function of the latter and there is a case for saying that the management was guilty of somewhat wishful thinking with its previous guidance.

What does Acme Packet Do?

Essentially, Acme is a play on the convergence of voice and data networking into just data or rather Voice over Internet Protocol (VoIP) provision.  Whilst this appears to be a inexorable trend, the rate of adoption is subject to question. In addition, it operates in very competitive markets with the likes of Cisco Systems $CSCO and Sonus Networks $SONS The former has already articulated its belief in a broad-based spending slowdown whilst the latter has talked of strong growth in its markets and made a recent acquisition (Network Equipment Technologies), which is seen as strengthening its competitive position. Indeed, this may turn out to be a competitive issue.
The key customers for Acme are the telecommunications service providers and, for example, Verizon (NYSE: VZ) accounted for 16% of total revenues in the last quarter.  So what went wrong?

Service Providers are Still Not SpendingThe market has known that the telcos were holding back on spending for some time now but unfortunately this is not something that Acme’s management has successfully factored into their guidance. Until now that is!

Indeed if we look back at what some of the largest players like AT&T $T and Verizon are saying, there has actually been a downgrading of capital expenditure plans as the year goes on.  In addition, other telecommunications equipment suppliers have been reporting weakness. These aspects were covered in an earlier article linked here.

It is therefore quite puzzling to look into Acme’s previous guidance and read optimism over a second half pick-up, particularly when there appeared to be no confirmatory sign in hard orders or revenues that the market was recovering. It appears to be a classic case of management’s listening to the sales force and then failing to adjust for their (the sales force) exuberance by tempering guidance.

Guidance Too Optimistic?The basis of Acme management’s argument for retaining its 10% top-line guidance for the full year was that the revenues for the first and second half would follow the usual 42/58 split. Unfortunately, this forecast contains little account for the current reluctance of the service providers to commit to spending. And that reluctance has now forced Acme to lower guidance.
And it is a whooping downgrade.

With the explanation being given as
“We are disappointed with our preliminary results for the second quarter.... Our top line results were principally impacted by continued weakness in the North American service provider market. We are completing a full review of our operations and will provide a further update on July 26th."
Investors should note that the usual bugbear of Europe was not mentioned, nor was the government vertical highlighted as being weak.

We should always be careful not to conclude too much from such a simple statement, but frankly putting the pieces of this puzzle together creates a picture of a company that has been too exuberant in its assumptions and guidance, in particular with its expectations for growth in capital expenditures from North American service providers.

Another issue clouding the situation 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 service providers purchase end-to-end or peer-to-peer solutions, they can be seen as competing for network spending dollars. Moreover, according to many other companies in the telco sector, wireline spending is moderating more than wireless.

When Highly Rated Companies Fail to Hit Guidance

The consequences of a company trading on a high PE coming out with disappointing guidance are plain for all to see. Even after the mid teen percentage fall, Acme still trades on a PE of 33, not to mention a EV/Ebitda ratio of 13x. This stock is not cheap on conventional methods and the growth rate and adoption of VoIP is likely to be moderated in analyst forecasts.

The end markets for Acme will surely improve in time, but for the foreseeable future the company is going to have to demonstrate that it is really an industry issue and not a company-specific concern. Potential investors should listen carefully to what Sonus Networks says and look for signs of a stabilization in telco spending.

In addition, Acme’s management is going to have to rebuild confidence in the stock and in their predictive outlook before cautious investors will be tempted back in.

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