Growth Still the Story for Networking Firms, Even as Profits Trickle In

You would think that young Internet-equipment makers would be quick to brag about their profits and quick to explain the differences between their businesses and money-losing Internet storefronts. Amazon.com (AMZN Quote), after all, is meeting with newfound skepticism about its top-line focus.

But fundamentals still carry little weight in the Net-equipment sector, which continues to fuel gains in the Nasdaq even as the electronic storefronts lose their luster. Executives flee from the suggestion that profitability is their No. 1, or even their No. 2, objective. They talk a similar market-share, land-grab game as do their brethren in Internet commerce -- even as the networkers increasingly produce black ink, which the e-tailers typically haven't even approached.

So even as rate concerns hamper the financial and retail sectors, for instance, investors continue to chase growth in the tech sector regardless of the old verities of consistency and profitability. And as the old-line Dow Jones Industrial Average slips under the pressure of rate worries, the Nasdaq has resumed its record-setting ways of late 1999.

What Have You Done for Me Lately?

Just this week, Juniper Networks (JNPR Quote) and Redback Networks (RBAK Quote), two newly public builders of Internet infrastructure equipment, joined peers such as Extreme Networks (EXTR Quote) in the profitability club.

Late Wednesday, Redback reported its first profitable period, earning $2 million, or 4 cents a share, in the fourth quarter ended in December, excluding amortization of deferred stock compensation. Analysts had expected only a penny of profits, according to a survey by First Call/Thomson Financial. Redback reversed a pro-forma loss of $2.6 million, or 9 cents a share, a year earlier. Revenue jumped to $26.1 million from $4.5 million.

Late Tuesday, Juniper reported its own first profits, making $4.8 million, or 3 cents a share, excluding extraordinary items, topping estimates by 2 cents and swinging from a year-earlier pro-forma loss of $8.6 million, or 21 cents a share. Revenue grew to $45.4 million from $3.8 million.

Supply and Demand

But today's investor isn't demanding profits.

"I don't think [profits are] that significant," says Ajay Diwan, the Goldman Sachs analyst who follows networking companies. "Unlike the classic Internet plays, there's no doubt they can make money," adds Diwan, whose firm has acted as an investment banker for Redback and Juniper.

"The metric people are paying more attention to is the sequential growth in revenue," says equity analyst Mark Edelen with Thomas Weisel Partners, who rates Juniper a strong buy and Redback and Extreme a buy. (His firm underwrote a stock offering for Extreme.)

"Profits are important, but investment and building the fundamental assets of the company come first," says Scott Kriens, CEO of Juniper, which like Redback and Extreme is headquartered in Silicon Valley. Juniper curtailed profits, Kriens says, partly by making R&D investments that equated to 40% of revenue last year. A milestone for the quarter was shipping its newly developed router to customers.

Opportunity Knocks

Juniper's rise from little-known start-up to success story in less than a year epitomizes the opportunity that investors see in the sector. Its engineers, many poached from sector leader Cisco (CSCO Quote), have designed a new network router with software tailored specifically to enable ISPs and telephone carriers to ease traffic bottlenecks in the thickest pipes of their networks. By contrast, Cisco historically has focused on corporations. In the September 1999 quarter, Juniper already had claimed 15% share of its market, whittling Cisco's piece to 78%, according to the most recent estimates from market-research firm Dell'Oro Group.

And ventures that rush to profitability earn no special treatment. Shares of Extreme, profitable for a year, suffered recently amid worries that it merely would meet Wall Street's expectations in the December quarter. But Extreme, a 4-year-old company that makes switches for local networks, delivered, beating estimates by 2 cents a share. More important, it showed progress in shipping new products to help manage traffic flow for customers such as Broadlink, a wireless carrier, and the electronic-commerce site Adauction.com.

Extreme increased its revenue to $55 million from $47.2 million in the prior quarter and from $18 million in the year-ago period. CEO Gordon Stitt of Extreme says his company has shipped enough units to demonstrate that "there are people betting their businesses on Extreme."

Both Scott Kriens and Gordon Stitt expect investors start valuing profits some time in the future. But right now they believe focusing exclusively on profits, at the cost of expansion efforts, would be cheating shareholders of a tremendous growth opportunity.

And right now shareholders aren't treating them like Jeff Bezos.