Metalink (Nasdaq: MTLK) issued another profit warning. The XDSL chip manufacturer, whose shares were recently listed on the Tel Aviv Stock Exchange, reported
at the end of last week that it will not meet its reduced forecast for Q2 2001, due to the weakness of the US and European communications market.
Metalink's Q2 2001 revenue will total only $3-3.5 million, half the estimate published by the management in early May. At the time, while Metalink was publishing good Q1 results, the company admitted it is not immune to the market slowdown and warned that its Q2 revenue would fall 10-20% compared with Q1, to $6.5-7 million. It is not necessary to wait for the management's assessments to realize that something is rotten at Metalink.
In the weeks preceding the first profit warning, several analysts and industry sources responded to a "Globes" article, which reported that Metalink would not be able to evade the telecom crisis. Metalink CEO Zvi Shukhman nevertheless declined to respond to "Globes'" questions about whether Metalink's business is waning. Silence is also an answer.
Metalink's problems began when its main customer, Copper Mountain Networks (Nasdaq: CMTN) of the US, which develops SDSL-based modems that enable high-speed data communications and Internet transmission, simply collapsed. Large volumes can be written about Copper Mountain's collapse, but briefly, the failure can be attributed to an unripe target market. Cooper Mountain's customers were CLECs, the alternative communications providers that sprouted to compete against the existing operators. The company provided the CLECs with broadband solutions for the high-speed transmission of data communications and Internet. When the capital markets collapsed, they took the CLECs down with them. What does this have to do with Metalink?
Metalink was deprived of its future growth engine, the SDSL modems, which were supposed to be the cornerstone of Copper Mountain's systems. Sales of SDSL modems in the last quarter, mostly to Copper Mountain, totaled less than $1 million, while sales of Metalink's traditional product line of HDSL modems to Europe, where they are mainly used by companies that want to implement broadband communications, provided the bulk of the company's $7 million revenue for the quarter. Metalink still forecast that SDSL sales
would rapidly become the company's key earner. After all, the HDSL market is quite limited.
Metalink is a fabless chip player. The company manufactures modems using DSL (Digital Subscriber Line) technology. These modems allow analog information on telephony networks to be translated into digital information used by computerized networks. DSL technology led to products (called XDSL) that, in turn, yielded two sub-technologies: ADSL and HDSL. ADSL is an asymmetric digital broadcasting method which is suitable for most private consumers' needs. The technology can deliver relatively wide bandwidth, but not at high speeds.
Metalink uses the second technology, HDSL. This technology uses symmetric broadcasting, i.e. two-directional broadband transmission. The system is used mostly by business customers, and its 2 Mbps transmission rate is faster than ADSL's.
SDSL technology, designed for the US market, was developed from HDSL, which utilizes two pairs of copper wires. SDSL requires only a single pair of wires for symmetrical communications, making it applicable to the household market as well. And that is not all.
Telephony companies are battling the cable companies, which can also provide subscribers with high-speed Internet over their current network. The telephony companies demanded a new weapon from their chip suppliers: Products able to transmit high-quality, multimedia files quickly over telephony networks. The companies believed such products would reduce the gap between them and the cable companies that led the market. The concept was that people still prefer watching multimedia material on their televisions rather than their computer screens.
The introduction of the new VDSL chip could change things. VDSL can transmit video files over telephony networks. Metalink is a key player in the VDSL market, and the company's future chip will be able to transmit voice and data in addition to video files. A number of potential customers chose Metalink as their preferential chip supplier for the market segment, although revenue is expected only next year. Shukhman says, "Metalink continues to win design contracts with leading global communications operators that support the company's technology, which supports three applications: Video, voice and data. We believe that the solution, together with the forecasts of deployment by the sectors communications providers, will greatly contribute to Metalink's activities."
But, as mentioned above, this will not happen overnight. Until it does happen, if ever, Metalink can expect hard times. Last week's profit warning reflects, more than anything else, the fact that the HDSL market is also dying.
Meanwhile, Metalink's future growth engine, the SDSL modem, also has vanished, leaving the company with its old HDSL chip product line for the European market. Only four months ago, Shukhman defined this sector as a "cash cow".
"Our HDSL chips have very strong sales in the ILECs world," explained Shukhman, adding, "We have a 70% market share. I'm not trying to delude myself and claim everything is wonderful, but, on the other hand, you can see that our main customers are immune because of the positive momentum in Europe. At the same time, we're able to reach markets that lack DSL. All the new emerging markets create growth. I cannot therefore declare that the macroeconomics isn't working and that the telecom market is in crisis as far as we're concerned. That would be a distortion. We'll present several new products this year, and I hope someone will listen to us. In any event, if we continue at the current rate, with the assistance of advanced technology we're developing, then we can be cautiously optimistic."
Unfortunately, reality slapped Shukhman in the face. HDSL chip sales fell 50% compared with the first quarter, because the telecom crisis infected the immune companies of Europe.
In the wake of the profit warning, Shukhman attributed the dramatic plunge in revenue to the cancellation and postponement of orders by many of the company's customers. "The market slump has affected Metalink in the short term," said Shukhman. "We're therefore taking steps to cut operating expenses. The company will, however, continue developing advanced VDSL and G.SHDSL products."
“Globes”: It's no secret that Metalink's business is in a slump, but the scale was quite a surprise.
Kardan Capital Investments research department director Yaniv Pagot:
"DSL standards have been established in the past few months. G.SHDSL was decided upon. This is a chip that allows high-speed symmetrical communications over longer distances than other chips. The moment the standard is determined, it directs all the market players in the sector to work accordingly, because customers want products that meet the standard. For Metalink, this means that the SDSL market, which is also suffering from weakness in the US, no longer exists."
Metalink is developing products with the new standard.
“Although Metalink is developing new products, it's important to reach the market in its early stage, and it appears that some of Metalink's competitors are in a better position. Globespan (Nasdaq: GPSN), Broadcom (Nasdaq: BRCM), and Infineon Technologies (NYSE; XETRA: IFX) already have advanced products based on the new standards that they are about to offer the large communications operators. Metalink's strategy is to offer these customers next-generation VDSL products. These advanced products have new standards, and Metalink will try to convince its customers to use its product instead of the competitors' existing ones."
Why would customers agree to replace the products?
"Because of the technology. Metalink signed contracts to design chips with ten customers, some of them industry leaders, and there's fairly definite potential, although the fruits will only be seen next year."
What will happen in the immediate term?
"Metalink will face hard times in the coming quarters, and I think the company will have $20-25 million in revenue this year, with first half sales of $11.5 million. In its favor, the company has very small inventories, and unlike other companies, there's no need to worry about inventory write-offs."
"Along with the ongoing economic slowdown, I think customers will continue pressuring prices. Although the market is small and limited, and chips constitute only a small part of the price of systems that are sold to the communications operators, in slowdown conditions, there's pressure on prices all along the supply chain."
It seems that Metalink will have trouble standing alone. Wouldn't it be worthwhile to combine forces with another company in the sector?
"Metalink has a lot of cash reserves, thanks to its two issues. The company can continue to be a player for a long time to come. It's not dependent on a merger. I think, however, that Metalink will ultimately merge or be bought. It's not a question of if, but when. I reiterate, it's not a matter of necessity. Metalink won't have to negotiate from a position of weakness."
"There are a lot of mergers and acquisitions in the chip industry; there were almost 200 in the past year, when large companies were unceasingly buying companies and technologies they lacked in order to expand the solutions they could offer their customers."
Who might merge with or buy Metalink?
"There are two main types of companies that might combine with Metalink. One type is large chip manufacturers that want to enter the DSL chip design sector. As I mentioned earlier, in the past there were no industry standards, but the market has matured and standards have been put in place. Large companies will want to take shortcuts and acquire ready-made companies."
Who?
"Texas Instruments (NYSE: TXN) might be interested."
Who are the second type of interested companies?
"Competitors. External growth is very acceptable in the sector. It confers a big advantage, and companies want to expand their product range and production. This lowers production costs and increases bargaining power vis-a-vis customers and suppliers."
What would be a good price for Metalink?
"I think a deal could be closed at $15 or even $20 a share."
It may or may not happen. Investors in the second issue really won't care very much. They have already lost 85% of their investment, and even under Pagot's optimistic scenario (indeed, too optimistic for our taste), they will recover barely half of their investment. Metalink held two issues, in late 1999 and March 2000, raising a cumulative $200 million. Of this sum, $50 million slipped into the pockets of Shukhman and another founder, director Uzi Rosenberg. Other "friends" realized shares in the second issue, including Oppenheimer analyst Lior Bregman, who was simultaneously recommending the share at a target price of over $70 and selling his own holdings.
Today, the share is trading at $6.40, reflecting a market value of $116 million. The company has $90 million in cash, which means that Wall Street estimates Metalink's business to be worth $25-30 million. This is also something. The problem is that Bregman estimated the company business (excluding cash) at $1.2 billion. Who says that sales by parties at interest and associates do not provide hints about the future?
Published by Israel's Business Arena on 25 June 2001