Farewell to a Wireless Winner

11/08/2007 12:00 am EST

Focus:

Nikhil Hutheesing, editor of Forbes Wireless Stock Watch, says wireless equipment provider Ceragon has made big gains and may be ready to sell.

Ceragon Networks (NASDAQ: CRNT) develops transmission equipment for both wireline and wireless networks, but the company's real growth has been coming from its wireless business. Its main business consists of selling to service providers "backhaul" equipment that connects access nodes (say, a cellular tower or a WiMAX tower) to the core network.

Ceragon has some big opportunities ahead, especially as a high-speed wireless technology called WiMAX is deployed. The company could also benefit from increased sales to emerging markets. This gives Ceragon the opportunity to provide equipment for capacity upgrades in developed markets, as well as new network construction throughout emerging markets. India, in particular, represents a huge opportunity.

But Ceragon faces big challenges. Nokia Siemens Networks (NSN), a joint venture created by Siemens and Nokia just over a year ago, has been a terrific customer, accounting for about 14% of Ceragon's revenues. But that's a lot of revenue coming from one company. And NSN may consider manufacturing in-house the very products that it currently buys from Ceragon. Such a move would put a dent in Ceragon's sales, and it would also put the company up against a much bigger competitor.

I'm also concerned about Ceragon's margins. The company's gross margins had been around 40% up until 2005 and then began falling. They are now around 36%-at the high end of expectations-but the margin strength came from Ceragon's private networks business (where it sets up networks for companies). This business has higher gross margins than its other wireless businesses, but a dip in demand for corporate networks is likely, and that will lead to pressure on margins.

Adding to those problems is a lawsuit filed by NEC claiming that Ceragon is infringing on its intellectual property in some of its products. Ceragon is trying to settle by offering NEC $450,000 and permitting NEC to cross-license a patent, but it's not clear yet whether this will be enough or whether NEC will continue to pursue higher damages.

Ceragon, which generated revenue of $58.4 million in 2004, is now on track to generate $161.5 million this year. This month, Ceragon announced that it will increase the number of shares outstanding by 6.9 million, diluting the stock by about 24%. But more important, Ceragon is asking for shareholders' approval to increase its share count to 60 million from 40 million, which means that we could see further offerings, diluting the stock by more.

Ceragon is also pricey. CRNT's price-to-sales ratio is 4.44x compared with 2.18x for rival Harris Stratex (NASDAQ: HSTX). Ceragon's shares are also currently trading at 43x 2008 earnings per share estimates, [versus 20.8x] for Harris Stratex.

While the company is in good financial condition-it has $24.5 million in cash and no debt-I think that the near-term concerns make shares of Ceragon look increasingly risky. Given that its stock has just about quadrupled since I recommended it in 2005, I believe that now is a good time to sell. (It closed just above $14 Wednesday-Editor.)

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