ENTERPRISE COMMUNICATIONS EQUIPMENT:
MANUEL RECAREY - KAUFMAN BROS LP
Analyst Interview - published 05/22/2006

DOCUMENT # ZCC801

MANUEL RECAREY, an Analyst at Kaufman Bros., LP, has more than 10 years
of experience covering communications service and equipment companies.
Prior to joining Kaufman Bros. in August 2004, he followed
communications equipment stocks at First Albany Capital. Before that, he
covered communications service and equipment companies at Fahnestock &
Co. and Gerard Klauer Mattison. He has been regularly quoted in
financial publications and a guest on financial TV shows. He has a
Bachelor of Science degree from the Stern School of Business at New York
University and he received his CFA designation in 1998.

Sector: it services

TWST: Please give us an idea of what you are covering in the Internet
infrastructure space.


Mr. Recarey: I cover the enterprise communications equipment market,
which includes data networking, PBX, video conferencing and handset
manufacturers.

TWST: In general terms, what's been going on from a business
perspective?


Mr. Recarey: From a business perspective, enterprise spending in the
fourth quarter was pretty solid and the March quarter was weaker due to
typical seasonality. Those companies that execute well continued to do
so and those that have been struggling continued to struggle. It seems
that if vendors can demonstrate a strong ROI and an improvement to
productivity, budgets are available. If not, they won't be.

TWST: When you say the fourth quarter was good, was there any particular
segment or was it pretty much across the board?


Mr. Recarey: I would say it was fairly much across the board. The video
conferencing market and data networking areas were pretty solid.
However, the PBX manufacturers were a little weak, but not terribly so
as they are managing through the transition to IP from TDM.

TWST: As you say, there was a seasonal dip in the March quarter. If you
look a little longer term over the balance of this year or into the next
year, where do you see the opportunities in this space?


Mr. Recarey: I see video conferencing as one. I think with the move
toward voice over IP and converged networks, a lot of the complexity of
video conferencing is being reduced and, as a result, it is becoming
easier to implement and for the user to utilize. So I see that as one
big opportunity. The other is within the Layer 4-7 portion of data
networking. F5 Networks (FFIV) continues to do well and Foundry Networks
(FDRY) has improved significantly. Both companies posted very solid
numbers for the March quarter.

TWST: What's going on in the data networking space that makes it
attractive at this point?


Mr. Recarey: The trends driving data networking are convergence,
applications moving toward the Web, and collaboration to better connect
and improve the efficiency and productivity of enterprises, partners and
suppliers. Data center consolidation and the centralization of
information along with the need for more efficient access and
application performance are also catalysts.

TWST: So this is all the network world that we are talking about.


Mr. Recarey: Yes, this is the combination of convergence and
collaboration. It's not just running different types of traffic over one
network and getting some cost efficiencies. It is taking it to the next
step where applications and the communications networks are integrated
to improve the competitive position and productivity of a company.

TWST: Is it beginning to filter down to medium-sized and smaller
enterprises as well?


Mr. Recarey: Yes, they certainly think so. Look at Avaya (AV) and Cisco
(CSCO). Both are increasing their focus on the small and medium size
business market as they see a lot of opportunities there. Large
enterprises have the technical expertise to be able to implement
convergence by themselves and have been the more aggressive group to
embrace the move to convergence. I think smaller companies will begin to
make the transition now as well.

TWST: So it is really beginning to spread out and get greater use.


Mr. Recarey: Yes.

TWST: What does F5 bring to this marketplace?


Mr. Recarey: The company is the leader in the Layer 4-7 switching market
and especially within load balancing. Its products are best of breed and
ensure high availability, scalability and optimized performance of the
applications that reside in a data center.

TWST: Who is their customer?


Mr. Recarey: This is mostly larger enterprises in different verticals,
including financials, energy, public sector and Internet companies.

TWST: Whom do they compete with?


Mr. Recarey: Cisco is probably their biggest competitor. Juniper (JNPR)
is starting to focus more on this area and so is Citrix (CTXS). Foundry
Networks is also looking to move into this area.

TWST: It seems there is no shortage of competition.


Mr. Recarey: There never is in the communications equipment industry.
There are also many small private companies that are being established
and becoming new competitors.

TWST: Given that, what's their competitive advantage?


Mr. Recarey: Its competitive advantages include its best-of-breed
products, Big-IP Version 9 platform, iControl open API and TMOS
operating system that allows you to add features and functionality in a
very efficient and rapid manner.

TWST: If you look out over the next couple of years, what kind of growth
do you expect them to generate?


Mr. Recarey: On the top line, probably 25% to 30%, and something similar
on the bottom line. The company has had a tremendous run over the past
three years, with an operating margin of somewhere around 30%. I do not
believe there's a lot of margin expansion left. But I still think that
there are plenty of opportunities on the top line.

TWST: What's the risk with the story?


Mr. Recarey: The risk in the story is that the competition catches up a
little bit, especially Cisco. Cisco is really focused on this area as
evidenced by their view that this market can grow to $1 billion a year
in revenue for them. So, with Cisco owning 70% of the whole networking
market, many customers may just wait until Cisco has the product
available and just go with that. That's probably the biggest challenge
that F5 faces. And then you have Juniper, which has been trying to get
into this market and increase their exposure among enterprise companies.

TWST: You mentioned best of breed as one of their signatures. As
companies and major companies particularly continue to look for suites
of product, are they going to be able to survive with the best-of-breed
approach?


Mr. Recarey: I think they will be able to survive. Cisco, as I said,
dominates the networking marketplace, but they don't own a 100% share.
So there will be vendors that will survive and thrive. From an equipment
standpoint, there will be many customers that will want best-of-breed
equipment and not be tied to a single vendor. So I think F5 will be able
to survive and to prosper.

TWST: The other one you mentioned was Foundry. What's the appeal there?


Mr. Recarey: If you go back to the beginning of 2005, Foundry struggled
a little bit. However, they introduced many new products in the middle
of the year that have contributed nicely to their rebound. In addition,
sales to the US federal government, which is a very big customer of
Foundry, have rebounded as well. So Foundry posted very good numbers
over the past three quarters, including the March quarter, which some
investors viewed as a disappointment. It was the second highest
quarterly revenue the company ever recorded. In our view, Foundry is
able to compete against Cisco and others because its products are on the
leading edge of technology and their customers are at the higher end.
For example, they are the leader in the 10 gigabits space.

TWST: You say that some people were disappointed in the March quarter.
Why?


Mr. Recarey: I think this is one of those instances where there was a
lot of momentum in the stock and investors' expectations were for F5 and
Foundry to continue to outperform. Since they only met expectations,
investors were disappointed. And because the stock was richly valued at
well over 30 times 2006 estimated earnings, the stock fell on the news.

TWST: The old story, not quite good enough.


Mr. Recarey: Exactly. They were a little bit of a victim of their own
success.

TWST: Where are the opportunities for them over the next couple of
years? You mentioned government. Is that their strong suit?


Mr. Recarey: For Foundry, the US federal government, the Department of
Defense and other agencies offer a lot of opportunity. Also large
universities that want cutting edge performance are another area of
continued potential. So I think their ability to continue to execute and
bring new products to the marketplace that are leading edge is what will
determine their success.

TWST: What kind of growth rate do you foresee for this company over the
next couple of years?


Mr. Recarey: The growth rate is not going to be as strong for Foundry as
it is for F5. My guess is it's probably in the mid-teen type of range. I
do expect on an annual basis to see some margin improvement over the
next 12 months, so I would expect EPS to yield faster growth. But right
now, I still maintain a hold rating on Foundry. Even though the stock
price has come down some recently, it's still fairly richly valued at 27
times or so 2006 estimated earnings. So even though I like their
prospects, I maintain my hold just due to valuation.

TWST: In this space, you mentioned Cisco a couple of times, saying this
is a big opportunity for them. Are you going to see some rollups of some
of these smaller companies by somebody like Cisco seeking to expand
their opportunities?


Mr. Recarey: I don't see Cisco purchasing any data networking companies,
especially any public ones. Its acquisition strategy is typically to
purchase small private companies for technology that Cisco needs.
However, I think the whole data networking space would certainly benefit
from consolidation. I think if 3Com (COMS), Extreme (EXTR), the data
products from Hewlett-Packard (HPQ) and Nortel (NT) were all combined,
the result would be a company that's big enough to better compete
against Cisco, a reduction in the pressure on pricing and a healthier
marketplace. I'm just doubtful that consolidation will occur.

TWST: That's the issue.


Mr. Recarey: A lot of these companies have a very strong balance sheet
with no debt and lots of cash, so there is no real catalyst for
consolidation.

TWST: How about on the video conferencing side? This is a space we have
heard about for years, but it doesn't seem to have happened. Is it
finally beginning to?


Mr. Recarey: I think it's finally beginning to occur. The wait has been
long considering that over 40 years ago AT&T (T) first introduced the
videophone at the 1964 World's Fair in New York City. But I think due to
the updates in technology, the bandwidth that's available, the move to
converge network and the deployment of IP, the complexity of video
conferencing is diminishing and ease of use is increasing. With just a
few clicks of a mouse, users can now go from an IM session to voice or
video conferencing very easily and without any IT person being involved
to help set anything up. I think these developments and the fact that
desktop videoconferencing is starting to gain traction are positive
trends for the industry.

TWST: So the technology is finally getting to the simple stage.


Mr. Recarey: Yes. Computing power at the desktop is getting there. The
network supporting the traffic is also getting there. So I think that
over the next 18 to 24 months, we will start to see interest in video
conferencing accelerating.

TWST: Again, is this happening from the big company level down or are
some of the smaller companies taking advantage as well?


Mr. Recarey: I think it's the big companies and consumers that are
driving it. As people get more comfortable with the idea of using video
and the benefits that it brings, video will become more prevalent within
an enterprise or business environment.

TWST: Who is the beneficiary? How should investors play this?


Mr. Recarey: The two companies that I look at are Polycom (PLCM), which
is the largest video conferencing vendor in the world, and Radvision
(RVSN), which is an Israeli-based company that trades here in the US.
Radvision is both a play on the deployment of desktop video conferencing
within the enterprise and also the buildout of 3G wireless network in
Europe and Asia and eventually in the US. For 3G wireless operators,
video is the only way to distinguish the next generation of mobile
services versus just adding more voice. Radvision is a beneficiary of
that trend. Those are the two companies that I focus on for video
conferencing.

TWST: What does RadVision bring to the market?


Mr. Recarey: They have a very close relationship with both Cisco and
Microsoft. So I think that they're well positioned there to capitalize
upon the trends that those companies are pushing. On the 3G side, it has
a very big opportunity over the next three to four years once the 3G
operators move from a trial to a deployment stage, and the company is
the leader within that marketplace.

TWST: Certainly, 3G is further advanced in Europe and Asia than it is
here. Have they gotten traction in those markets?


Mr. Recarey: Yes. They are in over 40 trials in Europe and Asia with
different carriers including Hutchison, Vodafone and Orange. These are
very large companies that they are dealing with, and they have about 70%
of the market share right now. I don't expect them to stay at that
level, but I do expect them to be able to maintain a very healthy market
share. I estimate it could be a $300 million opportunity for them over
the next three or four years.

TWST: So, certainly significant.


Mr. Recarey: Certainly significant for a company that I estimate to be
somewhere around $90 million in revenue this year.

TWST: What's the competitive risk for them?


Mr. Recarey: On the 3G side, Polycom really doesn't have any products
right now, though they are in the development for it. Tandberg, which is
a European-based company that is the number two player within video
conferencing, has a product from a startup company that they bought in
mid-2005. But they are not as advanced as Radvision is. Tandberg is in
maybe a quarter of the number of trials that Radvision has been in. So,
from a competitive standpoint, I don't see anyone that is going to come
in and just take the market share away from Radvision. I think their
success will be determined by how quickly the 3G operators are going to
deploy video services.

TWST: So that is the unknown part of the equation at this point?


Mr. Recarey: Exactly. It's more of a question of when as opposed to if,
but that 'when' could be a long time; we just don't know.

TWST: As you look at the company, are you recommending it at this point?


Mr. Recarey: Yes, I do recommend Radvision. I have a $25 price target,
and it is about $16 now. It had a great run through from the end of
2005. This year has weakened a little bit due to a misunderstanding by
investors on an acquisition of a private company by Cisco within the
video space. This acquisition is involved within the video surveillance
and security area, which has nothing to do with what Radvision does. So
I think the outlook remains very bright for this company and I maintain
my positive outlook for the company.

TWST: How about Polycom, what's the story there?


Mr. Recarey: Polycom is the leader within the video conferencing and is
starting to see a pickup in video conferencing for a conference room. In
addition, customers are beginning to show an interest in desktop video
conferencing. Polycom also is experiencing significant growth with its
voice products. Everyone is familiar with the Polycom phones in a
conference room, which have been doing very well as IP has been
implemented. So Polycom is a play on the collaboration of voice and
video onto one network.

TWST: As we go along, are we going to see lots more of that?


Mr. Recarey: I think so. That's the one I'm betting on.

TWST: What kind of growth would you expect at Polycom as we look out?


Mr. Recarey: Polycom's growth is probably in the low teens on the top
line. I do expect the company to expand its margins from its current
mid-teen level to around 20%. So, with that, I expect a faster growth on
the bottom line of around 20%.

TWST: With rapid growth in this market space, do they see much
competition?


Mr. Recarey: The video conferencing market has been a fairly sleepy
marketplace. There has always been a lot of hype, but they never fulfill
their potential. Polycom is the number one player, Tandberg is number
two and Radvision is number three. There are a number of Chinese vendors
that are out there as well. But from a competitive standpoint, I think
all three are well positioned since they have greater scale and
expertise than their competitors.

TWST: So, being established gives them an advantage in this space.


Mr. Recarey: Yes, I certainly think so since it will be difficult for
Cisco or others to develop the expertise that Polycom and Radvision
have.

TWST: How about on the other side of this coin? Are there any names that
worry you at this point?


Mr. Recarey: Some of the data networking companies such as 3Com and
Extreme have struggled, and I think will continue to struggle due to the
fact that their ability to compete against Cisco is limited. They lack
the size, scope or market reach to compete very effectively. So those
are two of the companies that I think are going to continue to face
difficulty going forward.

TWST: Thank you. (TJM)


Note: Opinions and recommendations are as of 5/8/06.

MANUEL RECAREY
 Kaufman Bros., LP
 800 Third Avenue
 25th Floor
 New York, NY 10022
 (212) 292-8132

Copyright 2006 The Wall Street Transcript Corporation
All Rights Reserved


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