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 CALX - 33%, ADTN - 21% in two days. Profit drop at Adtran followed by a sales warning at Calix. The problem is disappointing orders from several U.S. telcos. Both are respected for good products and good support but some quarters like this have been inevitable for a while. U.S. telcos are cutting wireline spending to well below depreciation. The price drops aren’t proportionate to the news.
The price moves are best explained as implying the street had unrealistic expectations. I’ve been reporting for several years that wireline capex is dropping and further broadband builds limited. Some investors may have been confused by the rhetoric from D.C. about support for more broadband. That’s just politician talk. Verizon essentially ended FiOS and U-verse currently is ending at AT&T. Even worse, the $7B broadband stimulus is mostly being squandered, judging by how little is actually built or even planned.
Both companies have the resources to bounce back after weak quarters. Adtran is a solid company with total debt less than cash on hand and short term investments. The “miserable” second quarter showed a profit of $21M. They’ve been profitable each of the last fifteen years. Capital spending is low ($11M in 2011). That may be because much of the R & D is treated as a current expense, a good conservative practice.
Adtran’s solid products and reliable traditionally allowed them to charge above-market prices. That’s much harder now. Shadgan Kheradpir at Verizon was so aggressive using their clout to bring down supplier prices Tellabs turned down FiOS contracts. AT&T also toughened up on suppliers. With almost half of the U.S. market, they offer suppliers “take it or leave it” price demands. Supplier margins across the industry have been going down.
Adtran long has relied on a very profitable but obsolete product - T-1 lines for big carriers. A low-end 3G cell site is typically served by five 1.5 megabit T-1 lines. The U.S. has 100,000+ 3G cell sites. For several years, remarkable growth in wireless data kept the product alive, but T-1’s have reached their natural endpoint. HSPA+ and 4G require 20, 50, or 100 megabits of backhaul, difficult or impossible to service with copper. AT&T and Verizon have been massively upgrading to fiber backhaul, typically designed for a gigabit. That’s sure to free up T-1 gear for their remaining needs. 100 megabit microwave gear now costs about $10K and is proving reliable, another alternative to T-1.
Businesses traditionally bought T-1 lines because of a reputation for reliability. The big telcos have cut so many employees T-1 reliability has fallen; in New York, I’ve heard many horror stories. A New York City initiative for commercial broadband http://betabeat.com/2012/06/mayor-bloombergs-big-plan-to-improve-broadband/ was inspired by complaints from Internet businesses they needed an alternative to Verizon. T-1 gear is HDSL and the service is similar to regular DSL lines sold much less expensively. With repair service on T-1 becoming so spotty, fewer are paying the premium. 3G and 4G wireless is expensive if heavily used, but works fine as an emergency backup.
Adtran’s strategy in response was an aggressive marketing campaign under new hire Gary Bolton to the smaller telcos in the U.S. and opportunities abroad. A hard-driving salesman, Bolton won some stimulus contracts and was making slow inroads abroad. The cost has been high; Adtran, long a premium source, has been the low bidder as they seek new customers. They probably should be spending more on developing new products. Their engineering under Kevin Schneider is strong; their protocols for DSL bonding are now in the standard.
Calix has no debt and had $50M in the bank at the beginning of Q2. As FiOS ends and Calix customers become the main fiber builders, Calix has become the #1 supplier of fiber home in the U.S. They won the bulk of the stimulus contracts, which are finally becoming firm orders. I played a small role as Vermont Tel chose their supplier for 22K lines of fiber home, where Calix was unanimously agreed best partner for build. They had done a consistently good job backing the gear VTEL had bought from them previously. Calix also did an exceptional job promoting their customer successes, perhaps leading Wall Street to project higher than realistic sales.
Calix in a 10K notes, “We have a history of losses and negative cash flow, and we may not be able to generate positive operating income and cash flows in the future. We have experienced net losses in each year of our existence. For the years ended December 31, 2010, 2009 and 2008, we incurred net losses of $18.6 million, $22.4 million and $12.9 million, respectively. As of December 31, 2010, we had an accumulated deficit of $411.6 million.” It certainly makes sense Calix would do better after they built a large base of customers, but the road to profitability was always going to be challenging.
Rosy crystal balls on Wall Street could keep the stock price up only so long.
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