Redback Networks (RBAK)

Bought a small position of RBAK at $10.05

The primary qualitative reasons why I bought this stock are that:

• RBAK is a play on the telecommunications sector, particulary for equipment that improves broadband Internet applications, i.e. enabling voice, video and data services over a common architecture. The telecom sector (and RBAK´s stock) was a huge favorite of investors during the bubble and it has performed miserably since then. However, the fact remains that the Internet continues to grow, and broadband applications are finally becoming mainstream. Investment in the real world is picking up again for telecommunications gear. RBAK will be a beneficiary of this predicted renewed, albeit much steadier, investment in telecommunications for broadband applications.
• RBAK is a post-bankruptcy play. During the bust phase of telecom, RBAK went bankrupt. It came out of bankruptcy in 2004. I have generally been successful with post-bankruptcy plays and these sometimes make for great stocks, primarily because the financials are still a bit confusing and there is a large potential shareholder base that can buy the stock as the story becomes more well-known. In other words, there is supply/demand imbalance for post-bankruptcy plays that favors the long side.
• RBAK has a new product, called SmartEdge, which is generating new contracts and leading to strong revenue growth. Because of SmartEdge there is potential for alot of good news coming out in the coming year.

Why Buy Now and Valuation

It appears that RBAK could show very strong revenue growth and renewed profitability starting in the second half of 2005 and into 2006, because of revenues from SmartEdge. The Smart Edge revenues are still not apparent in the public financials. So far instance, in the last quarter overall sales increased by 7%, but SmartEdge increased by over 100%. As SmartEdge becomes a bigger part of the company the overall financials of the company will begin to look very strong, with high revenue growth and profitability. When a company  starts reporting revenue growth and profits as opposed to losses, the stocks typically outperform for quite some time.

As for the valuation, the short answer is who knows. Since it is very difficult to estimate the revenues of RBAK´s contracts as well as future contract wins, you can´t really estimate the future earnings power of the company. But, let´s just say that this company has a huge amount of earnings leverage so when revenue growth kicks in, the earnings potential is very high. The company is currently valued at over $500 million, so in truth the company is not cheap by any traditional metrics. However, I´ve never made money worrying about valuations of technology companies heading into a strong revenue and profit growth phase, so I don´t really plan to worry about it here. If the qualitative factors mentioned above come to pass, the stock should double.

Holding Period

The plan is to hold this stock thru 2006 as revenue picks up and the company returns to profitability.

Risks

The primary risk here is that this is a story stock and the valuation is therefore somewhat suspect. Therefore, I expect alot of volatility and if market conditions are bearish this type of stock can get clobbered very easily. But over time, if trends for broadband equipment continue steady growth, the stock will do fine. Remember, this was once a $5,000 stock!

Comments

[putlovr]

For anyone looking at this blog for the first time, I "know" the creator. We met at a shareholder's meeting in 1999 and I have seen his posts on a message board from time to time. I have found his analysis to be thorough and well reasoned and have bought a few stocks he liked and made money in every case. The most recent was ABXA which he recommended on the KDE message board in August (?) 2003 when it was about 2-1/2. Its now three times that.