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Networking Startups: Racers That Can Never Rest Investors love the companies that help speed data on the Net. But one technology slip could leave them in the dust It's easy to see how excited Internet investors are about the new crop of networking stocks -- the companies that supply the routers, switches, and other high-tech boxes that are allowing a flood of data traffic to flow at increasingly high speeds over existing networks. Niche players such as Redback Networks (RBAK) and Juniper Networks (JNPR) have been some of the top-performing stocks this year. Both Redback and Juniper have soared roughly sixfold since their initial public offerings last spring and built market caps of $6 billion and $11 billion, respectively, even though they have yet to make a profit. Foundry Networks (FDRY), which climbed 525% on Sept. 28, its first day of trading, is the biggest IPO of the year. Other upcoming networking IPOs -- including Sycamore Networks (SCMR), which is expected out on Oct. 21 -- are widely anticipated by investors. "There is a huge opportunity for startups that have the new technology and can move swiftly," says Jeffrey P. James, a technology analyst at Driehaus Capital Management.
During earnings season, it gets a little easier to understand what the fuss is all about. Redback, for example, reported after the close of trading on Oct. 13 that its revenues grew 86%, to $20.6 million, over the second quarter. Although the company was still in the red by $600,000, or 2 cents a share, that was better than the loss of 5 cents that analysts were expecting. "It's hard not to smile with the third-quarter numbers and performance Redback had," the company's CEO, Dennis Barsema, said in a conference call with analysts and investors after the earnings release. With such strong results, analysts are likely to ratchet up their estimates, with some even predicting the company will go into the black by the fourth quarter. That would be sooner than generally expected, says Sockolow, who rates Redback a strong buy. (The stock fell 9 13/16 points to 135 1/16 on Oct. 13, mainly because of concerns that restrictions on stock sales following the IPO would expire on Oct. 18, potentially unleashing a wave of sellers and temporarily putting pressure on the stock price.) SWITCHING FROM THE YAHOOS? Juniper Networks, which James says has the fastest high-end router on the market, will report earnings on Oct. 19 after the close of trading. Analysts expect a loss of 12 cents, but investors will probably be disappointed if the results aren't better. In the first half of 1999 (its first year of product shipments), Juniper has already captured 13% of the revenues for core Internet protocol routers with its superfast M40 router, according to RHK, a San Francisco market-research firm. Cisco retains the other 87% of that market, but its share is down from 98% in 1998, says RHK. The prices of both stocks look lofty right now. But "over the next couple of weeks, we're going to see how these companies actually do," says James. "If they continue to beat estimates, valuations don't look as extreme." The theory behind such a statement is that the leading networking companies will serve such huge markets that current projections could easily be outstripped. "Valuations are rich, and that's a caveat in owning the stocks," says Sockolow. "But we're at the beginning of a build-out. The best management teams will compete to become the next Cisco." Of course, there are plenty of risks to bear in mind. Part of the reason the stocks are flying so high is that there is still a limited number of shares available -- and that the masses of Internet investors may be less interested for now in former highfliers such as Amazon.com and Yahoo! (YHOO) and may have switched to these and other Internet infrastructure plays.
Clearly, companies that don't stay in the lead technologically are headed for a setback. Witness what happened to Rambus (RMBS), which lost about one-third of its value after problems in its new high-speed memory chips were uncovered. While Juniper has had huge success with its high-speed router, a crop of competitors has plans for an even faster product, says James. "If Juniper can't go to the next generation, then it could fall behind," he says. The safest way to invest in next-generation networking stocks would be to buy a basket of them. "Many of these companies will get leapfrogged," says James. "That's why we invest in several of them rather than just placing a bet on one." That's easy for a large money management firm to do. But ordinary investors who take a chance with one of the current market darlings would do well to keep their stake small and a close eye on all the other startups waiting in the wings. Amey Stone is an associate editor at Business Week Online _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ |
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 Amey Stone covers the markets and investing for Business Week Online WEB POINTERS To visit some of the sites mentioned in the story, click here: Redback Networks Juniper Networks Driehaus Capital Brean Murray Ciena RHK Cisco Rambus | ||||||||||||
