Comverse Technology (Nasdaq: CMVT ) published its third quarter 2001 financial reports last night. They show that the company met forecasts, but also lowered its fourth quarter forecast. The new forecast states that revenue will be $265 million and profits will be $0.06 per share. If one-time expenditures are taken into account, Comverse could post a loss of over $0.20 per share by the end of the fourth quarter, reflecting a loss of $35 million.
A $30 million decline in advance payments from customers began in the third quarter. Customer credit fell by $20 million. At the same time, inventory shrank by $13 million and suppliers' credit rose by $7 million. There was a slight improvement in capital turnover, but the bottom line is that Comverse has less flexibility in negotiations with customers.
The projection that revenue in the fourth quarter will be less than in the third quarter is discouraging news. The fourth quarter is supposed to be a strong quarter, while the third quarter is supposed to be the weakest quarter of the year. In 2001, the third quarter was even weaker than normal, due to the 11 September attacks.
Nevertheless, Comverse's fourth quarter will be even weaker than the preceding quarter. In a conference call with analysts after the publication of the financial reports, Comverse's management said the company would not recover in one fell swoop. The fourth quarter of 2001 and the first quarter of 2002 are expected to be very weak. As for the second quarter of next year, Comverse's management expects slight growth, but it is not anticipating a dramatic rebound.
In the third quarter, Comverse began recognizing $30 million in deferred revenue as regular revenue. If Comverse had not recognized the deferred revenue as regular revenue, it would have had revenue of $265 million, the same amount it expects to take in during the fourth quarter.
At the end of the second quarter of 2001, Comverse's backlog totaled $253 million, and the company had $218 million in backlog orders at the end of the third quarter. Oscar Gruss Israel senior analyst Rami Rosen says, "On the positive side of the picture, we can see that the company has sold (products) almost a full quarter in advance."
The sales breakdown by products shows that Comverse's sales of voice mailboxes have been falling and now constitute 70-73% of all sales. In other words, total sales of voice mailboxes in the third quarter were $174 million, compared with $220 million in the second quarter.
Rosen says, "In order to achieve $1.1 billion in sales in 2002, Comverse must grow by an average of 2.5% per quarter."
In a conference call with analysts, Comverse Technology managers said they believed voice portals and MMS (multimedia messaging services) for third generation cellular have great potential.
For now, it seems that Comverse’s mobile Internet division is intended to be one of the company's most important strategic departments, because it is one of the company's most dominant and substantial future development channels.
The main problem with cellular Internet is that the development of cellular data transmission could be delayed in the near future. The cellular sector is stagnant, and the great breakthrough is supposed to come from third generation. But the moment it is launched, questions about financing costs will arise. It is becoming increasingly obvious that end users are not willing to pay $4-7 dollars for data-based cellular, value-added services.
Cellular providers are currently planning to charge service, content, and product suppliers high, percentage-based fees. The problem is that the business model is very complex. No-one knows how profits can be made. After all, the suppliers have ways to sell their services more cheaply, and via larger portals. In other words, no-one knows how to make money from cellular data transmission yet. So until further notice, the cellular operators will earn their money from air time.
The problem is that as the fees for data transmission over cellular networks rise, air time will fall, dragging down cellular operators' revenue with it. Industry sources think that since air time currently constitutes a significant cash cow for the cellular operators, it is quite possible that cellular data transmission will be of only secondary importance. It is now believed that greater stress will henceforth be placed on technologies that will increase air time.
This is where Comverse’s voice portal enters the picture. The voice portal allows a subscriber to access information delivered by cellular or non-cellular telephone, according to predetermined criteria. The voice portal allows information to be received or delivered by voice, without typing the information through the telephone keypad or reading the screen. The service can interface with e-mail, voice messages, and other applications that require the translation of data to voice. Voice portals are not yet sufficiently user friendly, but in the future they are expected to significantly ease cellular web surfing and allow people to avoid the difficult task of typing on tiny cellular telephone keypads.
Voice portals' great advantage for the cellular providers is that they create a great deal of additional air time. Assuming that at some point the voice portal will mature and work as it was intended to, it will become one of the most important applications driving Comverse forward in the years ahead. Its main drawback is that it will not generate revenue on the same scale as voice mailboxes. A second difficulty is that it takes a long time (six months to a year) to install the product at customers' facilities.
Comverse said in the conference call that it expected voice portals to play a starring role in the company in 2003.
US sources believe another market that will rapidly advance in the coming years is instant messaging. Although this is actually another name for data transmission, the sources believe the moment it becomes possible to transmit e-mail to cellular telephones, using instant messaging, the market will boom, allowing cellular operators to exploit a substantial part of e-mail traffic. The market is hoping the traffic will generate revenue for the cellular operators. Comverse is investing resources in this technology as well.
The present weak quarters at Comverse are not noteworthy, as they are partly due to market conditions. The important question is not what will happen in the coming quarters, but what will happen after the market recovers from the recession. When that happens, will Comverse also escape the doldrums, or will it still be in trouble?
The important issue is, therefore, what Comverse will do over the next 2-5 years. Will the company really reposition itself from a voice mailbox company to a producer of higher growth products, or will it be satisfied with improving its sales structure and cost streamlining, while remaining a voice mailbox company? Although Comverse recently invested $1 million in a new logo, this doesn't seem to have been enough of a change. We are still waiting to see a clear change in the company’s structure and thinking.
Mercury founder Arie Finegold once told “Globes” that one of the fundamental precepts of all companies must be a willingness to kill old products with new ones.
Cellular industry sources say that one of Comverse’s main problems is that its managers love their products. They devote too little time to listening to the changing needs of their customers, and possibly too much time and resources trying to convince the customers that they should buy what Comverse has to offer them. On the other hand, it should be remembered that in the past two years, Comverse has invested considerable resources in its attempts to find a new path.
In an interview Finegold granted after ten years of running Mercury, he said senior management should be replaced every ten years in order to make room for new people with new perspectives and refreshing ideas. Industry sources believe that Comverse’s management, however talented it may be, needs new directions and ideas.
In the meantime, Comverse’s new VP marketing, Benny Einhorn, is bringing new managers with him. Former Pele-Phone deputy general manager marketing Gil Bull is the latest addition to Comverse's corps of senior executives.
A capital market source recently said that another thing that might pull the Comverse cart out of the mire would be to acquire a company with complementary technologies, market share, revenue, and maybe even profits. Amdocs (NYSE: DOX) recently did just that, and the move is so far proving to have been brilliant.
From Comverse Technology to Comverse Infosys
There has recently been talk in the industry about a possible IPO of Comverse Infosys. The company had earlier planned to hold an IPO in 2001, but postponed it when the issues market closed and expenditures by organizations, the company’s target market, were halted. Now that Nasdaq is recovering and 2002 looks more promising, Comverse Infosys may very well revive its IPO plans, but it will need time to do so.
Factors that could adversely affect Comverse Infosys’ pricing include the market value for NICE-Systems (Nasdaq: NICE) (which operates in some of the same markets) and the repercussions of events at Comverse itself.
On the other hand, Comverse and Comverse Infosys operate in different markets and there is no relationship between their activities. Therefore, in principle, events at Comverse should have no affect on investors. Moreover, a successful IPO by Comverse Infosys could push up the share price of Comverse Technology.
In addition, investment banks are currently looking to float companies with strong and stable managements, market share, customers, and strong partners. Comverse Infosys seems to meet all these conditions. Another factor in favor of the company is that over half its business is in security, especially video and voice recording. In the wake of US President George W. Bush’s declaration of a long war on terrorism, the US security market is booming. The boom has created a very friendly environment for IPOs of security-related companies, which could help Comverse Infosys. There are many players in the security market now, but very few have real business.
In the third quarter of 2001, Comverse Infosys posted an $800,000 operating loss, but the company expects to post an operating profit in the current quarter, and grow by 15% in 2002.
Published by Israel's Business Arena on 13 December 2001