Full Disclosure Finance

By Andrew

In my last post I disclosed a holding in Sandvine Corp. (SVC.TO) and had promised a full fundamental analysis on the company. Well it was a rough week last week for shareholders of Sandvine. On Thursday Sandvine announced that they were cutting their 2008 revenue forecast to $80-85 million from the previous $100-110 million. The stock has fallen 62% since, closing today just over $1 per share. The adjustment came less than three months after Sandvine originally issued 2008 guidance ($100-110 million) which fell below consensus analyst estimates. The original announcement caused a significant decrease in the share price and, in my opinion, created a great entry point into the stock. But now after the most recent development I’m on the hook for a 70% decline in my position relative to where I bought in. Obviously my great entry point wasn’t so great after all. In my defense, my sentiment on the stock being cheap around $3 was echoed by a number of other individual investors including Justin, our friend Jeff McLarty over at Blue Moat, and a number of people we spoke to at Sandvine. Most of the analysts covering the company held similar bullish views including Scotia Capital who upgraded SVC to 1-Sector Outperform on March 3rd and Canaccord Adams who reiterated their buy on weakness on March 5th (the day before the revenue cut). I’m not stating this to justify my mistake. However, I am confident in saying that not many people saw this coming.

If you think about the reasons Sandvine stated for the adjustment it does seem logical and maybe that means that we should have seen it coming and been more cautious. In the announcement Dave Caputo, the CEO of Sandvine, stated that customers are taking longer to make decisions due to weakening economic conditions. Basically what he is saying is that the the credit crisis and subsequent slowdown in the US and global economy is starting to affect them being able to do business. In today’s market even hinting at the fact that your business is going to be negatively impacted by the weakening US economy is essentially the kiss of death. It is widely accepted that the US is probably already in the middle of a recession and there is a huge surge away from the ‘recession-affected’ and into the so called ‘recession-proof’ stocks. The equipment that Sandvine sells to Internet and wireless providers is a purely discretionary product at this point; it is a proven great technology but not essential for everyday business. So when things slow down and these providers are looking for ways to trim their budgets, spending $25 million on non-essential equipment probably isn’t at the top of their lists. Add to that the whole Net Neutrality issue and you’ve got the makings of a true battleground stock.

SVC is currently trading at a P/E multiple of just 7.6x trailing earnings. If the company can keep earnings relatively flat in 2008 and then continue growth in 2009, assuming the US economy has turned the corner by that point, the shares are very cheap purely on a valuation basis here. The company expects to do $8.2 million in revenue in Q1. To hit their estimates they will have to make up the remaining $72+ million in the final three quarters of 2008. This means they expect business to ramp towards the end of the year. Going into the slowdown Sandvine was well positioned to be the industry leader when it came to Deep Packet Inspection (DPI) technology. I believe that when the economy turns around and more providers adopt this technology, which they will eventually, Sandvine will still be positioned to be the industry leader. I remain bullish, albeit a bit more cautious now, on the stock and will probably add to my position to bring my cost basis down. I do believe that the most recent development is very negative for the stock in the short term. However, I believe the long term story remains intact. If you want to be long this stock I think you need to update your timeline from a 2-3 year timeline to a 3-5 year timeline at least. If nothing else, at these levels I have to believe that some of the major players in the Internet networking industry (Cisco anyone?) will be taking a close look at Sandvine as a potential takeover target to get a foot in the door of this emerging technology.

So that’s all for now on Sandvine. I’ll keep you posted on any new purchases or changes in the story.

Disclosure: Long Sandvine