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Tag: M&A

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Security Specialist Barracuda Reports 7% Revenue Growth; Margins Still An Issue

Posted on | by Narola

Barracuda Networks, a security/data protection solution vendor, yesterday reported $94.3M in revenues for the quarter ended August (~3Q17). That’s 7% growth from the prior year (June-August 2016). This growth rate would satisfy many companies, including lots of vendors selling into telecom networks.

Margins not going in the right direction

For Barracuda, a vendor focused on cloud-based security solutions to a wide range of vertical markets, the 7% is a step down. After going public in November 2013, Barracuda’s YoY revenues grew steadily in double digits. This was organic growth, largely, as the company’s few acquisitions had minimal revenue impact. In the last three quarters, YoY revenue growth has been in the 6-8% range. Some growth moderation is normal, as the company started from a small base. But this comes at a time when Barracuda is still struggling to make money. As shown in the figure, operating margins (operating income/revenues) have fallen in the last few quarters, and they were already low.

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IPO in November 2013

Despite low or negative margins, Barracuda has managed to stay free cash flow positive for every quarter since going public in November 2013. For the last 2 years, its average quarterly FCF was +$12.3M. Not a lot for a big vendor like Cisco or HPE (both competitors), but enough to leave a small one like Barracuda with a cash reserve of $207M as of August. That could be handy both for small M&A transactions, or as a buffer against a few more low-margin quarters. (Note that Barracuda’s net income has been in the 1-4% of revenues range for the last 7 quarters).

Several security rivals are losing money outright, including Palo Alto, Symantec, and FireEye, and Proofpoint. This last one is interesting. Proofpoint bills itself as a security-as-a-service provider, playing into a similar cloud-based security market. The company’s latest annual revenues of $376M puts it just $23M ahead of Barracuda (comparing fiscal year to fiscal year). Proofpoint’s current market cap is roughly 3x Barracuda, though. Proofpoint is growing much faster, with revenues up 42% in 2016. That growth has not come with positive margins; Proofpoint’s net loss was 30% of revenues for the year. Many expect Proofpoint (and Palo Alto Networks, and others) to grow out of their losses.

Made in California

Barracuda has physical products (e.g. the Next-Generation Firewall), not just software, and manufactures these appliances in California. To some, that might suggest higher production costs and/or slower delivery to customers. Barracuda’s cost of revenue is relatively low though, averaging 24% of revenues for the last 8 quarters. Turnaround time is also quick. Barracuda says most orders are received in the same quarter as the revenues are ultimately booked. One thing that helps here is, around 70% of Barracuda’s revenue comes from the US market, a figure that hasn’t changed much since going public. Also helpful is Barracuda’s vast distributor network, which should accelerate customer acceptance.

Balancing the revenue model

Barracuda gets revenues from both physical appliances, and subscriptions. In 2013-14, appliances accounted for 30% of revenues, with subscriptions the remainder. Since then, appliance revenues have been falling, down to under 20% of total in 3Q17. That’s not necessarily a problem. Subscriptions bring recurring revenues, after all. Further, if the margins on subscription services are high enough, giving away the appliance for free may even be an option. That’s not the case here.

Barracuda’s renewal rates are high, at 92% for the 6 months ended August. There’s no guarantee that will persist, though. Moreover, customers are opting for shorter contract lengths in fiscal year 2017. This adds uncertainty to revenue projections, and generates more work for the sales force. Average contract length, and Barracuda’s sales costs, should be watched closely.

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Third Quarter Earnings Season Around The Corner (And Yes, It’s Cloudy)

Posted on | by Narola

Over the next 3 weeks, companies across the communications sector will begin reporting third quarter (3Q17) results.

Watch for telco progress

The world has never been so reliant on secure communications, but the underlying market is in a bit of turmoil. The cloud and its key providers keep on growing, but many large telcos are treading water. They’re trying to cut costs (both operating & capital), and use modest investments and partnerships to tap revenue growth in areas like video/content and IoT. Many are also involved in M&A deals, which can help competitiveness if integrated well, but it can also make you lose a step. Nearly all telcos are under some level of competitive pressure from the cloud world, some extreme. As such, the most interesting earnings ahead lie in November, when most telcos report. But we’ll learn a thing or two in October.

Economic outlook stabilizing

The IMF’s Managing Director, Christine Lagarde, gave a relatively optimistic speech yesterday on the global economic outlook. Lagarde noted that the IMF’s last (July 2017) forecast projected 3.5 and 3.6% GDP growth for 2017 and 2018, respectively, adding that the forecast to be released next week “will likely be even more optimistic…Measured by GDP, nearly 75 percent of the world is experiencing an upswing; the broadest-based acceleration since the start of the decade.” She also noted some important risks, “from high levels of debt in many countries, to rapid credit expansion in China, to excessive risk-taking in financial markets.” The broadly positive tone was a plus for the communications sector, though, where revenues tend to be closely linked to overall GDP.

Wide range of companies play into the communications sector

The communications sector’s supply chain is long & complex, from chip vendors selling into networking & data center markets (e.g. Intel, Micron, Amphenol), to infrastructure vendors supplying hardware, software & related services directly to network operators (Ericsson, Huawei, Ciena); to services & software specialists (Amdocs, Mavenir, Nutanix), to the network builders & operators themselves. These can be telcos (Orange, Softbank, Verizon), cloud providers (Microsoft, Amazon, IBM), infrastructure specialists (Equinix, Zayo, Crown Castle), or part of another vertical market building large carrier-scale networks (finance, energy, government).

Most of the suppliers along this chain sell into other markets beyond communications; that’s most obviously the case at the chip level, but also for others, including IT services vendors. Some cloud providers (IBM, HPE, SAP, and Oracle in particular) are also large suppliers of IT equipment & services to telcos, who they compete with in some areas.

Another layer of complexity is manufacturing: few big tech vendors actually do this themselves nowadays, so electronics manufacturing services (EMS) players (e.g. Benchmark, Flex, Jabil) are also relevant. Note that some companies in the cloud (e.g. Facebook, Alphabet/Google) develop their own product designs, and contract with EMS/ODM partners to manufacture and ship to site.

Look for the cloud effect in October results

Despite the IMF’s endorsement for overall growth, the communications sector is less certain. Many big players are struggling with changes wrought from the cloud, and finding top-line growth isn’t easy. The growth of “the cloud” will be seen across earnings, sometimes indirectly. Cloud is motivating business strategy shifts, new investments, mergers, and layoffs. The latter subject will surely come up at Ericsson’s 3Q17 call, set tentatively for October 20.

Many semiconductor players selling into communications markets report earnings later this month, starting the 19th of October (TSMC) to the 30th (Cavium; estimated date). One of the early (19 Oct.) reporters, Maxim Integrated, also illustrates the impact of the cloud.

Maxim’s 2016 revenues were about $2.2B, flat from 2015 and down slightly from 2014. Last month, it announced a “business model update“. One goal was to increase operating margins, another to reduce dependence on individual large customers. Also important, though, is the need to better address cloud applications. Maxim does this through its “Comms & Data Center” unit, focused on data center optical connectivity & power.

When Maxim crafted its strategy shift, Intel’s dedicated “Data Center Group” (DCG) may have been on Maxim’s mind. Intel’s DCG revenues were $17.8B in the 12 months ended June, from $13.4B 3 years prior (3Q13-2Q14). That’s attractive growth, when it’s (mostly) organic and comes with above average margins: in the first half of 2017, 42% of Intel’s operating income came from DCG, which contributed only 29% of revenues. Intel reports on October 26th.

Some positive early news from an unusual reporter

Not all companies follow a calendar year-based fiscal year, and some also stagger their quarters. Accenture is an example. Its fiscal year ends in August. The benefit of this, for a market watcher, is that Accenture already reported its equivalent of 3Q17 (June-August 2017).

The results, published on September 28, are positive for the company’s “Communications, Media, & Technology” (CMT) vertical market. Accenture’s CMT revenues were $1.82B in 3Q17, up 7% YoY; CMT revenues for the 12 months ended August were also up, by 4%, to $6.88B. This is good for Accenture, but it’s too early to tell what it means (if anything) for the sector. Accenture provides a wide range of software & services to CMT players. Its growth could be driven by market share gains, or an expanding market: telcos are leaning more on vendors/partners (e.g. Accenture) in certain areas, which can expand the addressable market. Digital transformation is one area. Importantly, Accenture is offering a number of services geared towards new service rollout & management.  That hits what telcos need most of all: new revenue streams.

(Photo credit: Diego Jimenez)

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Comtech Expects Flat 2018; US Market An Issue?

Posted on | by Narola

If you follow telecom closely yet haven’t heard of Comtech, that’s no surprise.

Acquisition of TCS in 2016 doubled the company’s size

Comtech Telecommunications Corp. is far smaller than the biggest vendors in the  market (Huawei, Ericsson, Nokia, Cisco etc). But it’s nearly doubled revenues in the last two years, to $550M for the 12 months ended July 2017. A rough estimate of the telco piece of this is $200M, including both wireless & satellite. It’s worth checking out.

Most of Comtech’s recent growth has come from the acquisition of TeleCommunications Systems (TCS) in Feb 2016. That deal reinforced Comtech’s already strong position supplying specialty transmission and mobile data products to government end users. The deal also gave the company valuable distribution links into wireless operators, where TCS does well with “mission-critical C4ISR solutions and next generation emergency 911 services.”

For the new Comtech, the TCS deal has clearly helped it most in one segment: US customers not part of the federal government (figure, below). That includes US state & local governments, but lots of telcos as well. Comtech’s announced US telco customers include AT&T, Comcast, Sprint, Telefonica, and Verizon.

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From zero to $201M in debt

Comtech is in a stronger position post-TCS to sell both to government & wireless telco customers, but the deal came with costs. Prior to buying TCS, Comtech had $151M in cash on hand and no debt (July 2015). After the deal (as of July 2017), Comtech’s cash and cash equivalents balance was just $42M, and it now has $201M in debt.

To service its new debt, it needs growth (among other things). Yet revenues for the three months ended July 2017 fell 3% YoY, and Comtech is guiding the market for just 0-4% revenue growth in FY18. A tighter government spending climate in the US could be an issue. A coming slump in US wireless capex is another likely contributor. (And this is something to look for as Verizon, AT&T, and Sprint report earnings over the next few weeks.) It wouldn’t surprise me if these twin pressures encourage Comtech to make a bolder play in search for growth. As the CEO said on last month’s earnings call, “the integration of our TCS acquisition and focus on gross margin is largely complete. We have now shifted our focus from integration to growing our business.” Turning back to M&A is one option for Comtech, although it could end up being the target.

(Photo credit: Jake Sloop)

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China Mobile To Go (More) Global?

Posted on | by Narola

Buying opportunities

During the 2008-9 financial crisis, some wondered (including me) if the relatively flush Chinese operators would use the downturn as a buying opportunity into overseas telco markets. China Mobile seemed promising, given its (now even higher) cash reserve. CM did make a small move before the crash, when in 2007 it bought into Pakistan’s mobile market.

What’s actually happened in the last decade was, not much.

China Mobile has continued to invest in Pakistan, helping its “Zong” unit become the third-ranked player in the market. This year, roughly $200M of China Mobile’s 2017 capex will support Zong, to expand 3G/4G coverage. That’s less than 1% of CM’s projected capex of 176B RMB for this year, though. Overseas growth simply hasn’t been a priority for CM or its main rivals, given the size and growth rate of the domestic market.

State ownership implications

Chinese government entities retain majority control over each of the big 3 telcos. There’s nothing nefarious about this; it used to be common in most of Europe, and still pops up in a handful of other large countries. But it does clearly color investment priorities.

That’s certainly been the case in China. The government has been aggressive in using its ownership stakes, not just regulations, to manage the sector. China Mobile’s choice to invest in Pakistan in 2007, as opposed to say its neighbor to the east, was part of a larger strategy. That’s now culminated in the China Pakistan Economic Corridor.

Bailing out Oi?

With that, one recent story is interesting.

China Daily reported last week that China Mobile might be buying Oi (once known as Telemar), a Brazilian operator plagued by debt issues and undergoing restructuring.

Assuming it’s true, CM’s primary motivation would be ROI (return on investment). However. The China Development Bank would also be involved, per the story. CDB has been an active overseas lender in the telecom sector for many years (in Africa, for instance). It’s also active in Latin American telecom, partly through a $1B 2009 loan to America Movil. CDB has more of a political role than China’s other banks.

CDB lending is typically tied to some commitment to rely heavily on Chinese technology, and/or Chinese labor. As such, a CM/CDB-led acquisition/bailout of Oi will benefit Chinese tech vendors, all else equal. Ericsson, Nokia, Cisco and others active in Brazil will have to watch this very closely.

The bigger question is, will CM start to spend more of its cash stockpile overseas? It has 5B RMB in debt, true, but in the first six months of 2017 its free cash flow was 53B RMB, over 10 times that. Its cash and cash equivalents balance in June was 406B RMB, around US$61B. That’s plenty of buffer to expand, especially with support from the China Development Bank.

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Content cost crunch on the horizon?

Posted on | by Narola

Background

For several years, the telecom industry has faced a slow-growth climate. Telcos have adapted, cutting short-term costs as they position for longer-term cost reduction with efforts virtualization & software-defined networks. Most telco execs seem relatively confident that network costs will get in line, eventually. They seem more ambivalent about content.

Content costs keep on rising

Content is important to most big telcos’ growth prospects, and a central reason why cloud providers keep growing. But content is also expensive – both to buy and support in the network.

The biggest telcos have content budgets in the billions. While not many telcos report content costs, BT reports spending over $900M on content (“programme rights charges”) in 2016, for its base of 1.7 million subscribers. Established cable providers, even those who own production studios, have it just as bad. Comcast spent $11.6B in 2016 to purchase programming for its 22.5M video subscribers. That works out to over $500 per subscriber, in the same costly range as BT.

The related network investment to support this content is also hefty. Getting ARPU high and keeping churn low is essential for video platforms to pay off, and you don’t do that with choppy service.

Content also has some “soft” challenges. Most technology deployed by telcos and cloud providers is global, with little variation in basic design and function across country. Content varies dramatically by culture & language, and the R&D/production process is entirely different than a manufactured hardware product or software package.

Cloud providers serious about the content game

Many cloud providers have invested in their own original programming. Netflix gets most of the attention, but Google, Amazon and others have their own studios. Many also invest in early stage content development, in exchange for ownership rights, favorable licensing terms, and/or revenue sharing. Alibaba, for instance, plans to spend $7B developing content over the 2017-19 period. Another Chinese cloud player, Tencent, has its own “Tencent Pictures” arm, which spent ~$150M financing film projects last year.

M&A is an unproven solution

Telcos seem to be leaning towards acquiring their way out of the problem. At least for AT&T. Its purchase of Time Warner is coming along, and won’t be the last big telco-content merger we see – probably not even the last one in 2017. There are downsides to locking in content, though, when you also want to sell it on the open market. And Comcast, which owns both NBCUniversal and DreamWorks, hasn’t exactly solved the content cost puzzle; programming costs amounted to over 40% of its first half opex.

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Quad Play, At What Price

Posted on | by Narola

In the late 1990s, some telcos began wondering if buying cable companies might be a shortcut to deploying fixed broadband. That has happened in many countries, including Japan, Germany, Korea, and Spain. In most cases, a new entrant or second tier provider buys an established cable TV to get a quick foothold in the market.

What has happened less often, for good reason, is that an incumbent telco buys a cable TV provider in the same market.

Argentina regulatory change

Last week, Telecom Argentina shareholders approved TA’s plan to buy local cable TV provider Cablevision. The impetus is a regulatory change allowing more competition between the two sectors.

The government is hopeful that the change will bring new investment. That may come, but as often happens when regulations ease, at first we’re seeing the big providers getting bigger. This response has happened in many countries, not just Argentina. There is extra risk here, given the potential market power of a combined telco/cable network. One offsetting factor: the combined company will have a harder time filling its video pipes, as it loses ties to Grupo Clarin.

The dealmaker

This deal also calls to mind how important individual personalities – the dealmakers – are to bringing companies together. In this case, it was David Martínez Guzmán, who owns major stakes in both TA and Cablevision. His main task was getting buy-in from Grupo Clarin, which owned the 60% of Cablevision not already owned by himself. Bloomberg has called Guzman “one of the most mysterious” billionaires on Wall Street.

(Photo credit: Oliver Pecker)