Tuesday, December 11, 2012

Acme Packet's Long Term Potential

Acme Packet (NASDAQ: APKT) is one of those stocks that would test the patience of the most experienced investor. On the one hand, the world and his wife know that ISPs and carriers will one day ramp up spending on voice over LTE (VoLTE). On the other hand, everybody knows that telco spending has slowed this year, and the exact form of Volte spending (who will benefit and by how much) is still uncertain.  This is the sort of stock that you feel you should own at some point, but timing is everything here.

Signs of Optimism?

Earlier in the year there were some signs that Acme Packet’s core market of Session Border Controllers (SBCs) was actually a bit stronger than when it last reported. Essentially a company that rivals Acme in the SBC market, namely Sonus Networks (NASDAQ: SONS) had given an upbeat outlook for SBC spending.  Sonus confirmed that Tier 1 spending was weak but claimed to be gaining market share and that its SBC revenues were stronger than it had initially expected.

Indeed SBC revenues were forecast to sequential improve from $17-19 million in the Q3 to $22-25 million in Q4. Not bad at all and anyone could have been forgiven for thinking that Acme Packet might see some upside surprise in its next numbers.

Acme Packet’s Results

In the end when it did give results the market did like the numbers but there was no upside surprise. Instead it kept guidance pretty much in line and that was enough for a double digit move higher. The story of the quarter is one of weak Tier 1 spending with the main strength being seen in the SMB part of the SBC market and this was not good news for Acme Packet. Naturally, as the leading player in the market, Acme will position itself to benefit from Tier 1 spending so it’s possible that Sonus saw a stronger outlook due to its market positioning rather than a reflection of overall strength in enterprise spending. We shall see.

The odd thing about Acme’s results was not that North American carrier spending was weak (we have known for some time that AT&T (NYSE: T) and Verizon (NYSE: VZ) have been under pressure to reduce capex plans), but that European carrier spending was the bright spot. I would look at this development positively because it demonstrates that this kind of expenditure is not discretionary, it is critical, and at some point North American spending will ramp up. Indeed, Verizon was recently reported to be planning to launch VoLTE services by late 2013 or early 2014 and AT&T and Sprint Nextel are also believed to be planning similar developments for next year.

Tonight We are Gonna Party Like it’s 2014

In line with the rollout plans by the Tier 1 players mentioned above, Acme is hoping for a major ramp up in spending in VoLTE utilization in 2014 with a concomitant ramp up in spending in 2013. In other words, provided the economy doesn’t derail these rollouts then next year should be a much stronger year for Acme Packet.

Of more immediate concern would be the current weakness in enterprise spending, which has seen growth slow from 20% earlier in the year but is now forecast to be up just 5% for the full year.  In a broader context this mirrors the weakness in enterprise spending reported by Intel, IBM and others. Given that Cisco Systems (NASDAQ: CSCO) reported decent enterprise spending numbers in the last quarter but broad based weakness in the prior quarter, it suggests that Cisco is not going to report good numbers for enterprise spending in the upcoming results. Throw in its (Cisco's) reliance on North American carrier spending and some weaker numbers from the security companies like Check Point, or indeed other proxies for IT enterprise spending like F5 Networks, and it’s hard to be too optimistic about Cisco near term.

Where Next for Acme Packet?

This stock is becoming very interesting. I happen to think that telco spending will come back for the company despite the slowdown we are seeing now, and if you want to make serious money in stocks you have to take some risk on board. The risks here are for some near term difficulty in Europe -- it’s tough when you are relying on this region for growth -- and the usual caveats over a protracted slowdown in the US. I’m not so worried about the latter but the former is a near term concern even if things should get better in 2013.

With that said, Acme Packet has a solid balance sheet and is cash generative. If there is any sign that the Tier 1 carriers are spending again then this stock will fly, and it is well positioned within a secular technological chance (VoLTE) that no one denies will happen. It is just a question of timing. I’m going to be a coward and hold out for now, but investors looking for a little growth kicker by taking on some risk might well like the current weakness in the stock price.

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