Westwind anticipates near-term earnings disappointment at Sandvine

This research report falls into the category of “highly useful” to the various portfolio managers our there; an exclusive category. Westwind’s top notch software and services research analyst likes the Sandvine story (SVC:TSX), but he’s also worried about the aggressive earnings forecasts being published by some other players on the Street:

“We are initiating coverage on Sandvine with a BUY rating and a one-year target price of $6.00 per share. Our valuation is based on a DCF analysis using a discount rate of 12.5%, which yields a value of $5.78 per share using a 4% terminal growth rate. Our revenue forecast in F2010 is equal to the consensus revenue estimate for F2009, providing upside to our valuation if the company is successful in exceeding our expectations. Based on our F2008 forecast, our $6.00 target price equates to an EV/revenue multiple of 6.3x, an EV/EBITDA multiple of 26.0x and a P/E multiple of 52.2x; all of which are at the top range of the trading multiples of Sandvine’s peer group.

Recent stock price pull-back offers compelling entry point: Sandvine’s stock has recently
come off its $7.30 per share high achieved in September. While we recommend investors
start to accumulate shares at these levels, there could be an opportunity to purchase shares
at even lower levels after Q4/F07 results and guidance are announced. Our view is that
consensus expectations are aggressive, setting up Sandvine for some near-term earnings
disappointments. Over the long term, we expect Sandvine to be the DPI market leader
based on its first-to-market product roadmap, breadth of software solutions and proven
management team. In our view, Sandvine should be a core holding for investors seeking
exposure to the Canadian technology sector.

Customer concentration is our primary concern: Sandvine generated 54% of total revenue from its largest customer in the last quarter and 77% from its top two customers.

We expect quarterly results are at risk of missing expectations as existing large customer
deployments taper off. We would become more constructive on the stock once the company
adds additional large customers, which would help address customer concentration risk and
increase revenue visibility.

Strong macro outlook supports continuing revenue growth: We expect the annual market for DPI equipment to grow from US$125 million in 2006 to US$180 million in 2007 and to US$850 million in 2011. We take a fresh look at the DPI market and provide investors with a template for assessing the market opportunity. We believe that Sandvine has a significant market opportunity ahead as DPI deployments at telcos and wireless broadband providers gather momentum.

Our BUY rating is based on our view that Sandvine has the opportunity to win some large telco deployments, which would provide upside to our estimates.

We caution that we expect the telco sales cycle to take longer to execute and to be a lower margin business. We would become more bullish in our outlook once additional large contracts are announced.”

MRM