Sunday, February 17, 2013

Why I Bought Telco Play Ixia

It’s been a while coming but I’ve finally found a telco stock. I’ve been watching what the Tier 1 carriers have been saying about their capital spending plans and some key trends have been emerging of late. I initially set my heart on taking a closer look at Acme Packet but Oracle scuppered that idea by buying the company! As ever the challenge is to find the next play, and I think Ixia (NASDAQ: XXIA) fits the bill.

Ixia’s Exposed to Favorable End Markets

The idea here is that there are pressures building up on carrier networks from increasing smartphone and tablet penetration. According to what AT&T (NYSE: T) and Verizon (NYSE: VZ) said recently, not only are smartphone subscriptions increasing more than expected, the shift in spending from consumers towards wireless, LTE and next generation networking is gathering apace. At the same time the anemic growth in the economy has caused a lot of caution amongst their spending programs. In other words, the carriers are doing everything they can to avoid spending while at the same time seeing pressures build up. They have to start spending again sometime sand 2013 could be that year.

All of which leads me to network and data center testing solution provider Ixia. If telcos, data centers, device manufacturers and even enterprises are expanding their networks, they may also require monitoring ad visibility over the performance of the network. This is where Ixia comes in.

Customers Spending?

This year’s growth will primarily come from LTE roll-outs and the expansion of wifi networks. Ixia estimates that 50% of its business in 2013 will come from service providers and enterprises with half of its revenue being driven by application testing, security and visibility. Within that the major drivers are Testing, Assessing and Monitoring (TAM) for mobility and network visibility.

Its major customers are the likes of Cisco Systems (NASDAQ: CSCO), Ericsson, Alcatel, AT&T and Verizon. Cisco has long been a major customer, and its wireless solutions revenues have been growing at 20-30% annually for the last four quarters. Ixia described demand from Cisco to be ‘strong’ and suggested it would make up around 10% of its revenues for 2013. Cisco based revenues grew 30% in 2012. Indeed its latest results confirm strong growth.

AT&T is expected to contribute around 12% of total revenues, and I think there is potential for more in the future. It is behind Verizon in rolling out its LTE network. As for Verizon, it’s been a while since it contributed a large amount of sales for Ixia, but since it has now extensively rolled out an LTE network, it is seen as buying more LTE testing solutions from Ixia in 2013.

On a geographic basis Japan and North America are leading the way in terms of LTE adoption but they are still in the mid/early stages so there is plenty of growth to come. Similarly other parts of the world will surely follow so shareholders can expect successive waves of demand in future years.

Acquisitions Spurring Growth

In truth most of the current growth at Ixia is coming from its acquisitions (Breaking Point and Anue), and investors need to appreciate that as carriers invest in new networks they will hold off upgrading older technologies like 3G. This ultimately reduces demand for legacy testing solutions. Indeed, I note that its key rival Spirent reported numbers in November and disclosed that its customers were being cautious over spending. In fact its revenues were actually down 3%.

In turn it would be easy to look at Ixia and argue that the acquisitions caused the growth while the core revenues are flat. Indeed, the combined revenues from the acquisitions totaled $30.3 million in Q4 and $54.9 million in 2012 on the whole.

But the fact is that both companies are being integrated into the total Ixia offering, and if I am right about the ramp up in demand for Ixia’s solutions then the company has upside in 2013 from its existing product range as well.

I’ve discussed its core markets above, but there is a growing market for device and product testing as more and more of them are wifi enabled. In addition Ixia cited an order from IT security company Fortinet (NASDAQ: FTNT) as an example of how companies have a need to demonstrate the efficacy of its products. I hold Fortinet, and I noted that amidst its strong results it was particularly upbeat about mobility based revenues. Of course, Fortinet wants to use Ixia’s equipment in order to convince new clients that its solutions work well across a customer’s network, and this is a sign that other companies will also use Ixia in this way.

Moreover, any large enterprise that has large data center needs will need to monitor and asses its applications as they move around its network. I can only see this demand increasing in the future, and it presents a large expansion opportunity for the company to exploit.

Where Next for Ixia?

I think the stock is a good value and picked some up. It’s on a forward PE of 21 but, according to analyst estimates, it is set to grow earnings by 55% over the next two years. I think there is upside potential to those numbers with better than expected development of wifi enabled devices and LTE networking spending.

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