Ready for Their Close-Up

10/27/2010 11:08 am EST

Focus: STOCKS

Michael Murphy

Former Editor, New World Investor

Michael Murphy, editor of New World Investor, says a maker of equipment for wireless networks is poised to profit from a big technology transition in wireless broadband telecommunications.

DragonWave (DRWI) reported [earnings recently]—$27.2 million in sales and three cents a share [in earnings], well above the consensus.

(The Ottawa-based company provides Ethernet equipment for wireless communications networks—Editor.)

Clearwire (Nasdaq: CLWR), DragonWave’s major customer, is selling some of its spectrum to raise money to fund the next phase of its US-wide rollout of broadband wireless services.

A source quoted in a Bloomberg article said that AT&T (NYSE: T), Verizon Communications (NYSE: VZ), Deutsche Telekom, Time Warner Cable (NYSE: TWC), Cablevision Systems (NYSE: CVC) and Clearwire’s majority partner, Sprint Nextel (NYSE: S), have all expressed interest in bidding on the spectrum.

Clearwire needs to raise about $2 billion this quarter to fund its early 2011 rollouts, and that was the rumored size of a T-Mobile investment. But if Clearwire is able to raise $5 billion with this auction, as seems possible, it won’t need to raise any more capital to complete its rollout. I have always said that Clearwire will raise the funds, and DragonWave will remain the dominant supplier for its backhaul radios.

The spectrum sale is very good news, because it will get Phase 2 of the rollout started soon and let Clearwire complete its coverage goal sooner rather than later. Phase 2 should be worth about the same as Phase 1 to DragonWave: $175 million to $200 million.

On [its recent earnings] conference call, DragonWave focused on the trend to wireless broadband, both fixed and mobile, which will result in major demand growth for microwave Ethernet/IP backhaul. There are around five million wireless towers in the world today. The vast majority of those towers use either copper (DSL, T1) or TDM microwave backhaul.

Neither can cope with the kind of traffic growth we already are seeing, and there has to be a transition from these legacy backhaul technologies to the next generation, which will be either fiber-optic or high-bandwidth Ethernet/IP microwave.

This trend is accelerating in line with or even ahead of my expectations. [DragonWave’s chief executive officer said] that they are more confident going into the December quarter than they were going into the September quarter.

They were able to stay profitable at a very low revenue level, and recognized their first production revenue from the still-unnamed partner, [whom they said] they expect to contribute more than $10 million per quarter some time in fiscal 2012. They also said they are in field trials with what will be their second partner, another global major.

DragonWave spent about $9.3 million to purchase 1.69 million shares of their stock on the open market, at an average cost of $5.71 [per share].

DRWI is a Buy under $7 for a $14 target next spring and a $30 target exiting 2011 at about a $1.50 per share earnings run rate. (The stock closed above $8 Tuesday—Editor.)

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