Lazy, Hazy, Crazy...

Some summer reading to keep you up to speed on acr

The sun is shining. Nothin' but blue skies. The water's warm and inviting. Summer's here. But I don't have to tell you that it's still brutal out there. Miss earnings by a whisker and get your head cut off. Dip a toe in any price war's water, you'll drown. Take the wrong prescription for what ails the market, and you'll see nothing but a torch light inviting you to let go. Lost your conviction? Get in line. Jumped ship? Clich?. So, why am I smiling? Maybe I drank the salt water. Or, maybe I'm thinking that the very conditions that are brutalizing the market are the necessary ones for staging a comeback. Even as I can hear you say, "He drank the salt water," I'm going with the latter sense that we're setting the stage for a comeback--even if the actual script for it hasn't been written yet.

Speaking of script writing, you'll find enough new vocabulary below to make you want to return to studying Chaucer in Old English. The new economy speak is more baffling than its products. Nevertheless, learning the lingua franca of IT is part and parcel of unpacking where opportunities and pratfalls lie.

Leading up to March 2000, the telecommunications industry was stockpiling intellectual capital, human resources, and hardware like a harried housewife preparing for a family reunion. Unfortunately, the extended family never came and the major telecommunications companies were left with a plethora of supplies and a costly work force--all with a market shelf life of a bottle of milk. As the Street watched each and every loss, their stock prices soured. Many companies, like Tellabs (TLAB), have spent the past few quarters going from bad to worse. But, lately, the necessary tasks associated with cleaning house have begun. TLAB has liquidated much of its costly inventory and started reducing its workforce.

The good news, I think, is that TLAB's cleanup is almost over. How- ever, while TLAB won't be growing moldy, it also isn't likely to grow rapidlyanytime soon. This latter fact is environmental: It's stuck in telecom's sector rut. But I think the current demand for its flagship Titan family of optical networking products is stable enough to keep the company alive. When the next release of Titan comes out, I hope Tellabs returns to the path of steady growth. The Titan 5500 optical networking system is capable of handling various speeds and levels of optical input and cross-connecting them at high speeds. In simpler terms, it can carry the equivalent of 1.4 million simultaneous Internet calls. The newer Titan 6500 can carry the equivalent of over 4 million calls.

The broadband access business has three main product lines, the MartisDXX system, the Focus family of synchronous digital hierarchy (SDH) transport and access networks, and the Cablespan 2300 universal telephony distributions system. The MartisDXX system allows global telecommunications operators to maintain their local or global networks from one location. The Focus family of SDH and dense wave division multiplexing (DWDM) optical transport and access solutions are designed to help carriers build high-capacity backbone and access networks using fiber optics. (SDH stands for synchronous digital hierarchy, which is a standard technology for synchronous data transmission on optical media. "Synchronous" refers to the fact that the bits from one call are carried within one transmission frame--this method is faster and less expensive than plesiochronous--i.e., almost synchronous--digital hierarchy equipment, or PDH.) The Cablespan 2300 system is a local access product developed in cooperation with Advanced Fibre Communications, Inc., and geared to the emerging cable and alternate service provider markets. The system allows cable television providers, alternate access carriers, and competitive access providers to build flexible communications networks that support the integrated delivery of video, voice, data, and information services.

TLAB's next generation switching products are modular in design and can be used individually or in complex systems and assemblies. There are two areas within next-generation switching: Salix switching solutions and Verity voice-quality enhancement products. The Salix 7000 family of switches makes voice-to-data migration cost-effective by integrating circuit-switching into asynchronous transfer mode (ATM) and Internet protocol (IP) broadband infrastructures.

Verity voice-quality enhancement products are sold to cellular companies, local exchange carriers, and interexchange carriers, both domestic and international. These products are designed to make wireless calls as high in quality as wireline calls. (Tellabs acquired Salix and its product line in February 2001.)

The optical network market made up 64% of Tellabs' 2000 revenues. The Baby Bells account for about 1/3 of the sales of Titan 5500, while Sprint is the primary customer for the Titan 6500.

Tellabs' other, worldwide customers are long distance carriers, alternate service providers, cellular and other wireless service providers, cable operators, government agencies, utilities, and business end-users. Sales to these companies account for the remaining 36% of Tellabs' 2000 revenues, with broadband services accounting for 22% and next generation technologies a mere 6%. The final 8% comes from professional services designed to support Tellabs' wide range of technologies. Analysts and insiders agree that what growth will come in the short-term future will be from the optical networking divisions, which is a good thing, because despite their claim to build tomorrow's technology today, the current climate won't allow companies to look past the end of today.

TLAB's management is heavily invested in maintaining its long-term viability. Richard Notebaert joined TLAB in April 2000 and was named president in August 2000. In what many on the Street feel is a wise move, Notebaert is focusing the company on customers and markets rather than new technologies, in an effort to increase revenue to $6 billion by 2003. With founder and current chairman Michael J. Birck, Tellabs' top management team has an extensive background in the telecom industry and experience in riding out the sometimes-stormy telecom climate.

What makes Tellabs look even more attractive is the fundamentals. As of this writing, Tellabs was trading at $18.26 a share, with a P/E multiple of just 10 times trailing earnings, making it far more attractive than most communications equipment firms.

While the Street has been downgrading its earnings estimates, the company expects to break even for the 2nd quarter before one-time losses are counted in. This is a company with no significant outstanding debt and over a half a billion dollars in cash on hand. While the short-term picture has worried some, this doesn't simply look like a cheap stock, it is one. The long-term potential is good.

SERVICES

Integrated Circuits!

Yes, the exclamation point is annoying, but Avant!'s software products are anything but

While many stocks have been stuck where the sun doesn't shine, Avant! is a relatively cheap company with a sunny outlook from the semiconductor software industry. It remains an industry leader with consistent earnings and escalating growth estimates.

Avant! (that's the last time for the exclamation point) develops, markets, and supports integrated circuit (IC) design automation software solutions (from system definition to mask synthesis), for multimillion-gate products including systems on chip (SoC). These ICs power consumer electronics, Internet infrastructure, wireless, telecommunications, and automotive products. The company is the leading provider of physical foundation IP libraries for IC design and provides a full suite of software for integrated circuit design, process simulation, device modeling, and mask synthesis.

While many in the industry are scaling back, licking their wounds, and wondering if they'll ever get up after the fall, Avant just keeps going. It has announced new product releases and business partnerships, demonstrating increasing demand for its software. In the past few months, Avant announced a lucrative deal with NEC, which will use AVNT's Star-Rail software, the industry's first ultra-deep submicron sign-off solution for IR drop and electromigration analysis. Quite a mouthful, but the bottom line under this product is that Star-Rail is essentially a high-performance engine that enables full chip verification and does so at unprecedented speeds.

Another advantage of its product line is that Avant handles the majority of industry standard formats. In addition to Star-Rail, Avant recently announced Design VERIFYer 2001.2, software that accelerates systems on chip designs, as well as a support package for Linux SinglePass-SoC solutions.

While these advances are impressive, it is the company's recent legal troubles that have kept AVNT in the spotlight. On May 23, 2001, Avant pleaded no contest to allegations of stealing trade secrets from rival Cadence Design Systems. The judgment for AVNT in the criminal proceedings will be $27 million, while the company's CEO was personally fined $2.7 million. The case deals with software the company ceased licensing and supporting in 1996.

The essential details are that former Cadence employees were suspected of supplying source code for these products to AVNT. Local police and the FBI raided Avant's San Jose, California offices in December 1995. The day after, Cadence filed a civil complaint against Avant, which then filed a countersuit a month later. Shortly after that, Avant settled the suits, and investors responded positively, with AVNT closing up 20% for the day. While this clearly shows that many believe the trouble is behind AVNT, any judgment over Avant's current cash flow may be the only cloud on this company's horizon.

With a $443 million market cap as of June 26th, AVNT trades at an 85% discount to its P/E multiple of 5.5 , versus the 36.5 average multiple of the software & services subindustry.

TECHNOLOGY

Internet Test Case

Teradyne is no Johnny-come-lately to the tech party, but the wreck has hurt. What's next?

Teradyne produced its first diode tester in 1961 and its first integrated tester containing a minicomputer (to control a series of test steps) in 1966, beginning the automatic test equipment industry. But it wasn't until 1999 that TER was inducted into the S&P 500. (For a history of Teradyne, visit its Web site at www.teradyne.com.) Since then, TER has expanded to a global manufacturer of test systems, related software, and electrical connection systems, with offices and plants in Massachusetts, California, and overseas. Its products test and inspect semiconductors, circuit boards, high-speed voice and data communications systems, and software. As such, they're wed to the cyclical semiconductor companies, which have scythed many a semi-related stock intheir recent wake.

Teradyne's semiconductor test systems are used by electronic component manufacturers in the design and testing of logic, memory, mixed signal, and other integrated circuits. These test systems allow semiconductor manufacturers to measure product performance, improve quality, shorten the time to market, minimize labor costs, and increase production yields. Circuit board test systems are used by electronics manufacturers and companies in other industries that use circuit boards in high volume. They are used for the same purpose as the semiconductor test systems. The broadband test systems are used by the communications industry for Internet testing, customer care, and voice network maintenance. They perform qualification testing for DSL services, help locate network service problems, and perform integrated surveillance and maintenance for voice networks.

Teradyne's Connection systems produce backplane assemblies and other connectors for customers in the telecom, networking, storage, and server industries. A backplane is an assembly that circuit boards are plugged into. Connection systems are used in many different products and industries, from Internet routers to servers to data storage to telecom and aerospace.

In the last two years, Teradyne has sold off two of its product divisions. A controlling interest in its software test systems unit was bought by Matrix Partners of Waltham, Massachusetts, creating a new company called Empirics. Amphenol Corporation purchased Teradyne's aerospace and defense backplane connector business, solidifying its hold on the aerospace connector market. Teradyne had once dominated this business, but it had come to represent only around 5% of its revenues.

In June, Teradyne lowered its guidance for the second quarter of 2001 due to lower-than-expected demand for its products. The original guidance was for $425 million to $450 million in revenue just to break even; the revised guidance is for revenue of $350 million to $375 million. That translates to a loss of 5 cents to 10 cents a share, even with the benefits of the sale of the connector business. In addition, the company expects to incur special charges of 15 cents to 20 cents a share. The business is down by more than 50% from its peak in the third quarter of 2000. The company has laid off about 12% of its 9,600 employees, helping to cut labor costs by 25%, but these actions still will not allow Teradyne to turn a profit.

The company has not lost money since the first quarter of 1991, weathering several business downturns in the past decade. This most recent downturn can be attributed mainly to the fact that most of Teradyne's business had, in part, been driv-en by the Internet. Semiconductor test systems accounted for 67% of 2000 revenues; connection systems, 24%, and other test & inspection systems, 9%.

At a July 5 price of $35.90, and 174 million shares outstanding, Teradyne has a market cap of $6.3 billion, and sells for 14 times trailing earnings. And while the price is close to right, the semiconductor sector is still swinging on extremes, rather than returning to its market norms. Trouble is, if you wait for these norms, you'll have missed the opportunity in this stock.

SERVICES

Gold Bug

Some not-so-bad sites to whet your precious metals appetite

There's a correspondence between how heavy a sell is, and the worth of what is being sold. The heavier the sell, the more worthless the product. Nowhere is this more apparent than precious metals and their attendant sites.

Nevertheless, I don't doubt that more than a few of your clients have been bugging you lately about gold. Gold bugs are harder to kill than roaches--despite the fact that if you invested in gold at the expense of the stock market over the past 20 years, you might be living in a roach motel. If you're like me, the precious metals story hasn't changed, and simply doesn't add up. As an inflation hedge it's been sheared time and again. As a lasting defensive play, set on the various stages throughout the world where dramatic upheavals rend paper money into worthless slips of dictator-typeface, you'd want to own an M-16, not brick. As for the retail demand that was supposed to manifest itself in Asia and India, it hasn't happened--and it isn't going to.

If you're going to buy into any angle of gold's twisted investment tale, buy the Fidelity Gold (FSAGX) fund. Manager Niel Marotta is up 15.1% for the year (through July 3) whereas the S&P 500 was down 5.9%. But I wouldn't advise it.

I also would avoid gold coins at all costs. If you're really paranoid, buy $10,000 worth, put them in a plastic bag, and bury them under a tree in your back yard. Chances are that by the time you dig them back up, your yard will have appreciated more than the gold coins.

That's not exactly the message you'll get from investment sites that focus on precious metals. In fact, go to any site that purports to provide investment information on precious metals and you'll be sold, hard, on the need for gold. Today, the pitch is based on precious metals providing diversification for client portfolios. Among the least obnoxious sites: www.blanchardonline.com.

Blanchardonline.com deals in coins and metals ("deals" is the operative word here). But bait aside, it's a fairly well-put-together Web site. The "Investing in Rare Coins" link has an essay about the advantages of this kind of investment--the usual drill that I mentioned above. "U.S. Gold Coins" gives a rundown on the different types of collectible coins and has some recommendations regarding the acquisition of them. "Risk Disclosure" runs down a list of various risks associated with investing in rare coins and precious metals.

As for other gold sites, there's www.monex.com. You've seen Monex's ads on TV, and the site has the same goal, mainly getting you to invest in gold, silver, platinum, or palladium through its site. Then there's GoldMiningOutlook.com, an amateur Web site with a lot of commentary on investing in gold and gold mining.

Www.Eaglewing.com has multiple links, a fund of the week, and a real-time ticker for the reviewed funds at the top of the page. Www.the-privateer.com is a site that mainly covers gold, but also provides info about the Australian stock market.

There is a silver lining to the lackluster sites. I think the best site is the one that has very little to do with gold. Www.silverinstitute.org is a gold mine of information regarding all of the various modern and historical uses for silver. The "News Desk" link alone is more thorough than on any of the gold sites mentioned above, with links to several news/financial sites and articles going back for the past five years or so. So, if all the gold sites fail to glitter, this one, at least, delivers.

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