Investors Ring Up Net Phone Supplier

09/11/2007 12:00 am EST


Nikhil Hutheesing, editor of Forbes Wireless Stock Watch, finds a newly public provider of Internet telephony networks that is growing rapidly and reasonably priced.

As companies try to reduce costs and improve efficiency, they are increasingly turning to Internet protocol (IP)-based [telecommunications] networks. ShoreTel (NASDAQ: SHOR) provides companies with both the IP infrastructure that they need as well as the phones. Its customer service is better than many larger competitors and its prices are lower. As a result, ShoreTel has been winning customers away from bigger players such as Nortel Networks, Avaya, and Cisco Systems.

ShoreTel completed its initial public offering in July at $9.50 per share, raising $77 million. That day the stock was up 20%. Since then, ShoreTel's shares have moved up as high as $15.01 before falling to current levels [of around $12.50 Monday]. ShoreTel currently has a market capitalization of [above $500 million].

The outlook for this company is promising. For the fiscal year ending June 2007, revenue was $97.8 million, an increase of 59% [over] fiscal 2006. GAAP net income for [fiscal 2007 rose 50%].

While ShoreTel has traditionally generated about 99% of its revenue from North America, international revenue now accounts for about 4% of total revenue and I think we will see that number continue to increase since the company has been signing new distributor agreements.

ShoreTel also has a strong balance sheet with cash increasing to about $77 million since its IPO in July, and the company has no long-term debt. ShoreTel says that it plans to use the proceeds from the IPO to build additional brand awareness, making it a stronger competitor. The company also plans to broaden its channel programs—something it is already doing—to reach larger customers both domestically and internationally.

On a fundamental basis, the shares look attractive. SHOR trades in line with its competitors at about 3.9x expected sales for calendar year 2008. But next year, SHOR should have revenue growth of 34%, much higher than the 21% growth expected for its peers, which include Avaya, Nortel, Cisco and Mitel Networks.

If you look at other recent IPOs of communication companies such as Riverbed Technology, they trade now at a price-to-sales of ratio of about 4.8x expected revenue for 2008. If you apply that multiple to SHOR, you get a target price of $17 per share. The company's PEG ratio (price to expected earnings growth) over the next year is 1.2x, which is also in line with similar companies.

ShoreTel currently trades at roughly 42x expected earnings in 2007, but that is still less than Riverbed, which trades at 51x expected 2008 earnings, and Aruba Networks, which trades at 48x expected earnings.

Based on these projections, I expect SHOR to reach $17 per share within the next 12 months. While there are certainly risks associated with this small company, it has been growing impressively and the outlook is favorable. I recommend investors buy shares at current levels.

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