Polycom Exploits Aversion to Business Travel

Polycom (PLCM Quote), the California-based videoconferencing outfit, got a nice upgrade Tuesday from Pacific Growth Equities, and it responded with an almost 6% jump to close at $23.62. It continued to rally Wednesday, gaining more than 8% by midday to trade lately at about $25.53.

In upgrading Polycom from buy to strong buy based on current valuation, Pacific Growth said that Polycom looks good to hit its first-quarter guidance, and it expects the company to reach a price target of $45. (Pacific Growth has not been an underwriter for Polycom, but has worked with the company on other issues.)

If that proves true, that's quite a move from the stock's current level -- and a heck of a comeback for a company whose share price went almost straight up from near a buck in early 1997 to nearly $70 in fall 2000 and then fell even more sharply to $11 and change about a year ago.

Better Times May Be Ahead Polycom has had a bumpy ride over the past five years

The events of Sept. 11 put Polycom back on the growth curve, as analysts and investors expected to see much more audio- and videoconferencing and much less business travel. Indeed, Polycom immediately jumped about $6 when trading resumed and clawed its way up to the low $40s in early December. But since then, and especially over the past couple of weeks, it's seen a sickening slide back down to the low $20s. Now it looks ripe for a long-lasting recovery.

Factors in Its Favor

Polycom is one of those rare tech companies I like right now. That may sound odd to longtime readers, who may remember my condemnation of videoconferencing a few years ago. I do hate videoconferencing -- it's a stilted, awkward, synthetic form of human connection. But for the past few months, I've been using Polycom equipment in my office, and I like the way it has kept me off the road.

Moreover, I'm starting to think that videoconferencing is going to be part of the business landscape whether I like it or not.

Polycom came late to videoconferencing, having built its business on speakerphones -- what it likes to call audioconferencing -- with those weird three-legged phones now nearly ubiquitous on corporate conference-room tables. Polycom shipped its 1 millionth speakerphone in December.

Polycom's speakerphones gained that huge market share despite their cost: several times what we were used to paying, even for very good conventional phones with a built-in speakerphone function. The secret was the relatively good noise-canceling and echo-reduction circuitry Polycom developed. Finally, you could sit around a table and speak in a normal voice -- and the people in Cleveland could actually understand you. No more yelling "Huh? Say again? Whazzat?!" back and forth.

While Vtel (now privately held Forgent Networks) and PictureTel (now a part of Polycom) had owned the domestic videoconferencing department, both had dithered and failed to exploit that market. Videoconferencing is bandwidth-hungry, and the costs and complexity of ISDN (integrated services digital network, a communications standard) and other connections didn't help. But Polycom saw a new era of cheaper, easier-to-use IP (Internet protocol) broadband connections coming and acquired its way into control of the market.

The PictureTel acquisition gave the company a strong line of "room" systems, while buying ViaVideo delivered a classy "personal conferencing" system for individual PC users. Even with the reluctance of many businesspeople to travel after Sept. 11, the videoconferencing room-systems market is still slow, but desktop videoconferencing is entering what I think will be a long-lasting boom.

So it's easy to see why Pacific Growth analyst Brian Alger sees lots of room for Polycom stock to move up from its on-the-floor valuation. Alger told me Tuesday afternoon that he sees Polycom heading for an estimated $620 million in revenue over the next year, leading to 50% growth in profitability.

Valuation Issues

He thinks the current "half-PEG" price makes no sense. (PEG, or price-to-earnings growth ratio, is a common measure of current value as opposed to expected growth. It's the price-to-estimated-earnings ratio divided by the estimated three- to five-year growth in earnings.) "I mean, tech companies ought to be valued at a greater-than-1x PEG, maybe not 2x, but at least 1.5x PEG."

"This is a company with a great sense of where communications is headed," Alger said. "The advent of IP communications really helps -- you've got things like directory services and multipoint calls on a single IP connection. ISDN has [stunk] for so long; now Polycom can exploit that explosion in voice over IP.

"And the company is moving more manufacturing to Southeast Asia. I was worried that PictureTel would drag them down last quarter because PictureTel is still building its systems in the U.S. -- but even that didn't hurt," Alger said.

"And smart acquisitions, including Accord and Circa as well as PictureTel and ViaVideo, can drive this company back to its earlier pattern of growth and profitability. You have to exclude 2001, which was ugly for everyone, but they're climbing back on that path."

I don't set price targets, but if I did, I'd peg Polycom higher than Alger's estimate of $45. In a bleak communications-products landscape, Polycom's lines stand out and position it well for serious growth over the next couple of years. The only question is the velocity of that growth -- in other words, timing a buy. In the mid-$20s, I think there's relatively little downside in jumping on the train now.