Weakness in China Telecom Spending?

In the light of the recent profit warning from Ixxia $XXIA I decided to take a closer look at what other players in the industry such as $ARX Aeroflex, Spirent and Anite are saying. In summary, there does appear to be some weakness in emerging market network infrastructural spending. However, this may prove temporary and, merely a consequence of some caution from OEM manufacturers in the light of macroeconomic concerns relating to Japan and Euro zone sovereign debt fears.  In addition, handset and wireless appear to be growing well, so a pick up later in the year is possible.

As a note of caution I have sold off my Spirent position but retain Agilent $A as the co is more focussed on wireless solutions and the division does not make up more than 17% of revenues. The next company to issue a statement is likely to be Spirent in the UK when it gives half year results on the 4^th of August.

Company	Date	What they said	Global Markets?
Spirent	4th May	‘Trading performance for the period is in line with the Board's expectations and continues the positive trend that Spirent reported in its full year 2010 results’.	‘We expect to maintain progress throughout the remainder of 2011’
Finisar	15th June	‘Despite the decline in revenues compared to the prior quarter, we were able to achieve non-GAAP gross margin of 34.2%, exceeding our prior guidance of 32% to 33%’	‘The sequential decline in revenues was primarily driven by soft demand from our telecom customers, particularly Chinese OEMs’
Anite	29th June	‘Network Testing's prospects have been enhanced by the Invex acquisition and its growing global presence. Its broad suite of products means that it is well set to continue to grow, albeit in the first half it is unlikely to exceed the very strong comparative period last year.’	‘While Network Testing's revenue in EMEA increased by 33%, to £12.2m, and in the Americas by 44%, to £5.6m, in Asia it declined by 9%, to £6.3m.’
Aeroflex	7th July	‘Delays in shipment approvals from and orders of test equipment by U.S. government entities have caused Aeroflex to reduce its estimated ranges of net sales and Adjusted EBITDA to $198 million to $200 million and $56 million to $59 million, respectively’	‘we had some major achievements this quarter, including record sales of wireless test equipment, our first significant order from a major global manufacturer of wireless infrastructure equipment for next generation LTE(A) TM500 products’
Ixxia	7th July	‘Total revenue for the second quarter of 2011 is expected to be in the range of $67.0 million to $69.0 million, below the company's previous guidance of $78.0 million to $82.0 million.’	‘Second quarter 2011 revenue was impacted by several factors, including lower than expected revenue from Asia Pacific and from certain large equipment makers, as well as orders received late in the quarter that could not be fulfilled in the second quarter’

Network Testing Heading for a Weak Quarter?

I think that it is not unreasonable to expect Spirent to report some softness in this quarter, although it is not clear whether this is the start of at trend or a temporary pause. No matter, I have sold my position and will await their update. Ixxia have confirmed what Finisar said last month so it does appear that Chinese OEM’s have held back on spending.

 I suspect this is a consequence of a reaction to the events in Japan or alternatively part of the same forces that are holding back China LED street lighting expenditure. The latter is a subject well covered on this blog. It will be interesting to see how these pans out with Spirent’s next statement. In view of the sustained weakness in China LED street lighting I have decided to be cautious here.

Anite Signals Strong Growth for 4G and LTE Spending

Ixia $XXIA and Spirent $SPT investors got an early read across from wireless and handset testing company Anite $AIE. Anite’s gave a final results statement and gave the stock market an update on how 4G and LTE deployment is taking place.  In summary on their wireless division,

‘2011 saw improved financial performance within the Wireless division, driven by both customer spending recovery and organic business growth. We believe the recovery phase is complete and that its 2012 results will be driven by business growth alone. Wireless is better positioned to take advantage of its existing and new markets than in the past and we believe that the LTE opportunity is also likely to be deeper and longer lasting than previous technologies.’

In addition, Anite talked of increased investment in 2G and 3G products as well as LTE. This augers well for the likes of Alcatel, Spirent and Ixia.

However, the key to longer term growth is the demand pull from the use of smart phones with data demanding functionality. This is particularly relevant when IP and video data is increasingly being used because it is bandwidth intensive. Naturally, this puts pressure on the network operators and handset manufacturers and testing solution providers will benefit if their customers are under pressure to invest in new technologies.

Interestingly, Anite mentioned that the demand for legacy systems has..

‘proved more sustained than expected and we continue to invest in this area.  However our main focus is currently on LTE, although the pace of change is accelerating and we are already planning for the next generation.’

Growth in the Wireless Market

 Anite referred to the longer term demand drivers here

‘Sales of smartphones are expected to grow 61% year-on-year- making the market ever more complex. While there is little growth in voice and text in developed markets, mobile data traffic is expected to grow by 6.3 exabytes (1 billion gigabytes) a month by 2015, a 25-fold increase over 2010^’

Industry Handset Production Forecast (m)	2010	2015
2G GSM	700	300
3G (WCDMA)	400	950
LTE	0	75

LTE is being deployed quicker than 3G ever was, simply because the adoption of smart phones is driving the need for a network upgrade. This is distinct from the early 2000’s when 3G was rolled out before the handset technology existed to take advantage of the network. It really is different this time.

In general, this is a very positive update and augers well for Ixia, Spirent and Alcatel. There doesn’t appear to be any slowdown in network upgrades and legacy system sales are holding up well.

Ixia and Spirent, Two Great Stocks Set to Benefit from Internet Growth

 

Ixia $XXIA and Spirent Communications represent two great ways to play the roll out of next generation wireless technologies. These companies primary activity is 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 expanding margins and cash flow as their customers appear to be in the early stages of a sustained capital expenditure cycle. They are two great stocks to play the growth in internet and broadband expansion.

Growth Drivers

The argument here 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 utilising 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 Spirent & Ixia 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 and Spirent Solutions

These companies are strong rivals and compete in many of the same markets. Whilst wireless attracts most attention due to its growth, it should be emphasised that this produces a backload which is then dealt with by wire line. In other words, both these markets will see sustained growth.

A quick look at the geographic mix of revenues reveals a marked similarity.

 

Geographic Share	Spirent	Ixia
US	52%	51%
Emea	16%	15%
APAC/RoW	32%	34%

Both companies offer convergence performance testing and are seeing strong growth in Ethernet based infrastructure. In particular, the move towards 10GbE infrastructure should see continued demand growth. Within 3G/4G there is a strong trend (particularly in emerging markets) towards a deployment roll out as data centers and service providers.

Spirent provides ‘TestCenter’, which is its main network testing platform which assesses the vulnerability of traffic application load. Capacity and performance are tested via ‘Avalanche’ which operates on the ‘TestCenter’ platform

By way of comparison, Ixia offers IxLoad which tests converged services and application delivery platforms. IxLoad has been enhanced via the incorporation of IxDefend which was previously a separate vulnerability assessment solution.

Ixia does have Cisco as a major client and this could cause concern as Cisco have been disappointing the market recently. However, strong growth elsewhere has seen Cisco sales fall to less than 10% of Ixia’s revenues.

Spirent or Ixia?

Essentially, both look set for strong growth. Spirent has lower gross margins because it offers service assurance and has a oddly fitting division (Systems) which manufactures electronic control systems for electrically powered systems. This division is lower margin but nevertheless contributes 12.3% of revenues and 7.8% of operating revenues to Spirent.

Spirent looks to be cheaper on current evaluations..

Evaluation ($m)	Spirent	Ixia
Market Cap	1561	1120
EV	1338	1100
Gross Margin	66.60%	78%
EV/Rev	2.8	4
FCF/EV	6.20%	3.23%
Current P/E	19.8	34.1

...but Ixia has the edge on growth prospects

Analyst Forecasts	Spirent	Ixia
Forecast Rev Growth	9% , 6.7%	20.5% , 16%
Forecast EPS growth	10.7% , 9.4%	36.7% , 29.8%
P/E 1 year	18	30
P/E 2 year	16.5	19.2
Price/Rev 1 year	2.5	3.4
Price/Rev 2 year	2.4	2.9

It looks, assuming current pricing, like it will take Ixia a couple of years to reach the levels of cash flow yield that Spirent is at now. Moreover, Spirent has $223m in cash and could possibly sell the 'Systems' division, so the possibility exists for EPS enhancement. Indeed, the company recently made some share buy backs with its cash and this can be expected to continue.

Spirent was added to the portfolio.