Stratos International (STLW) Update

As is usually the case with our investments, we were a bit early into STLW, and despite what appears to be a stabilized business, with little downside risk, the market has until now firmly disagreed with our assessment, pushing the stock down  nearly 12% since our initial recommendation. However, the company's latest fiscal first quarter report released last evening confirms our belief that STLW is a low-risk technology play with significant upside over the next few years, and that despite the fact that the earnings statements still are not exciting, the situation looks likely to improve throughout this year and next.

After reviewing the earnings release and listening to the conference call, we came away with several positives:

• The company is still cash-flow positive, and is using excess cash to pay off remaining preferred stock, further strengthening an already clean balance sheet.
• Backlog continues to increase and the top-line growth continues to accelerate. Management feels that double-digit revenue growth is in store for the next fiscal year.
• There are still several interesting growth prospects in the next few years, but of course the industry backdrop is still very much uncertain as evidencd by the JDSU earnings report.
• The company will have positive news to report quite soon on its real estate holdings.

So if the outlook is most positive why is the stock down?
Well, there was one glaring negative in the report:

• Gross margins decreased dramatically in the quarter. However, this appears to be a one-time issue, and if that is proven to be the case, the company could easily be earnings profitable next quarter, on a similar level of sales.

Bottom-line: We are still holding on to our shares, in the hope that STLW's business prospects will continue to improve throughout this year and next. We remind readers that there is still an offer for the company at $7.50 per share, which is over 20% above the current stock price. As such, it appears somewhat irrational for the stock price to be selling this low, especially considering that cash now represents over 30% of the company's value. Additionally, the price/sales ratio is well beneath 1 on an enterprise value basis, even though sales are expected to grow by double-digit rates this year. We expect that with time, the stock price will ultimately move higher to reflect the company's improving financial results. If not, we believe that management will be forced to heed to the pressure of activist shareholders, sooner rather than later.

Disclosure: We hold shares in STLW. In addition, this report includes market analysis. All ideas, opinions, and/or forecasts, expressed or implied herein, are for informational purposes only and should not be construed as a recommendation to invest, trade, and/or speculate in the markets or in any particular stock. Any investments, trades, and/or speculations made in light of the ideas, opinions, and/or forecasts, expressed or implied herein, are committed at your own risk, financial or otherwise. We maintain no legal responsibility to update this report or his holdings in the stock mentioned in this report.