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Why I Remain Bullish On EZchip Semiconductor


By Gerald Gehman

The Undervalued Growth Companies portfolio continues to lag behind the Russell 2000 and the S&P 500. All the stocks in the Gehman portfolio are special situations. I believe the managements of the companies are working diligently to develop their businesses, but the stock prices haven't moved significantly.

I believe that each one of the investments could, and should, trade at significantly higher prices, but it won't happen until it happens. Below is my short analysis of each company.

EZchip Semiconductor (EZCH)

EZCH is my largest holding with the most exciting potential. On November 6, the company announced a record quarter for revenues and earnings.

EZCH expects all its customers who plan to use the NP-4 (Fourth Generation Processor) to be in full production by the end of 2013. The fifth generation processor, NP-5, is now sampling and is expected to go into production in 2014. The company says the NP-5 "doubles the NP-4 performance and port density, reduces the price per port for our customers and is expected to sell at approximately 50% higher ASP compared with NP-4."

Of greater importance, EZCH has developed and will start sampling their revolutionary New Processor for Smart networks in 2014, with customer product prototypes in 2015 and production in 2016. This NPS processor will provide superior performance, integration and flexibility to process "data plane" information at high speed - all on a single chip.

The greatest criticism that analysts make about EZCH is their customer concentration. The NPS will greatly expand EZChip's customer base because the NPS will provide unique processing to "our traditional customers, the carrier Ethernet router vendors, from the data center network appliance and switch vendors and from large carriers and data center operators that are innovating self solutions."

Cisco (CSCO) has been a great customer for EZCH, but the NPS will reduce the company's dependence on Cisco and the limited size of the edge router market.

In their latest NPU market report, The Linley Group said that EZCH "became, for the first time, the overall NPU market share leader, with 23% market."

EZCH's customers, five of the seven edge router providers, are extremely secure because of the significant time and money they spent to integrate EZCH processors into their systems.

Evidence of this is that Juniper first used the NP-2 in 2005, but Juniper's orders for this chip were larger in 2013 than in 2012.

For eight years or more, all routers that are built with EZCH processors will add more line cards (thfnsat use EZCH processors) to keep up with the gigantic demands for broadband capacity.

EZCH increased their cash position by $8.7 million, even though the company spent $4.5 million for R&D. EZChip's cash position has been building steadily with no significant debt.

Eli Fruchter, CEO, in the third-quarter earnings call said "now that NP-4 is in production with all customers, our continued growth rate depends on our customer's success with their NP-4 based platforms and on carrier spending that seems to have improved in recent quarters." Many reports show edge router sales robust and carrier spending, (e.g., ATT, Verizon, China Mobile) increasing.

I believe that EZChip's market dominance, future products, secure growing customer base and strong financial position should allow EZCH to trade at a much higher multiple.

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