With Internet Alliances on the Rise, Inter-Tel May Be Next

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As players jostle for position in the brewing Internet telephony business,

Inter-Tel

(INTL) - Get Report

looks like an ideal partner-in-the-making.

Companies such as

Cisco

(CSCO) - Get Report

and

Bay Networks

(BAY)

are devising ways to ferry phone calls over the Internet. To secure the best possible Internet telephony technology, some of these big concerns are partnering with companies that specialize in phone systems rather than data systems, which is where Inter-Tel comes in. A partnership agreement would strengthen Inter-Tel, and would likely boost its stock price.

"I think they've got a little bit of a lead on the other guys," says Jon Gruber of San Francisco-based

Gruber and McBaine Capital Management

, which is an Inter-Tel shareholder. Gruber says his firm might purchase more shares if Inter-Tel cements a deal to furnish a larger vendor with its components.

Alliance seems to be the name of the game in Internet telephony, a term that loosely describes the convergence of conventional phone systems and the Internet. On Monday, for instance, Cisco, the leader in data networking, and

NEC America

unveiled plans to jointly develop a corporate phone system that transmits phone calls using Internet protocol.

Other companies are also investing in Inter-Tel's small rivals. Earlier this month Bay Networks took a 9% stake, valued at $37.6 million, in

NetSpeak

(NSPK)

and is inserting the company's software into its products. In January, the German phone carrier

Deutsche Telekom

(DT) - Get Report

and agreed to purchase $30 million of its gear and services.

That leaves Inter-Tel, a Phoenix-based company with a $575 million market capitalization that has built a tidy business of supplying telephones and voice-processing software to corporations.

Inter-Tel trades at 2.7 times trailing sales. By comparison, NetSpeak, with a $247 million market cap, trades at 46 times trailing sales, and VocalTec, with a $168 million market cap, trades at 11 times trailing sales. On Monday, Inter-Tel's shares slipped 3/16 to 21 15/16.

Analyst Bruce Carlsmith at

NationsBanc Montgomery Securities

says Inter-Tel is well-positioned to partner with a larger supplier. Two possible candidates are

Cabletron

(CS) - Get Report

and

Motorola

(MOT)

. Officials at both companies declined to comment, although Cabletron acknowledges that it lacks the technology Inter-Tel has.

But Inter-Tel has been in no rush for such an alliance because its relatively large size makes it easier to thrive alone. In an interview, Steven Mihaylo, Inter-Tel's chief executive, says the company would seriously consider an offer to align with a larger supplier if it would accelerate sales efforts. But he stresses that the company doesn't need an alliance to prosper.

Internet telephony is expected to grow rapidly in the third and fourth quarters, generating 8% of the company's total 1998 revenue, up from almost nothing now, according to estimates from Carlsmith, whose firm underwrote an Inter-Tel stock offering in late 1997. If so, Carlsmith estimates, that chunk of sales might claim a 10% to 20% share of the nascent Internet telephony industry, a market that is expected to explode.

Carlsmith says Inter-Tel heightened its appeal by unveiling plans last month to sell its rich software separately from its hardware box. Inter-Tel also has an enviable customer-billing system, he says, which some competitors lack.

In the third quarter ended Sept. 30, 1997, Inter-Tel's net sales grew 20% to $56.9 million from $47.4 million one year earlier. Net income increased 48% to $4.0 million, or 16 cents per share, from $2.7 million, or 10 cents per share, one year earlier.

The company will report profits for the fourth quarter Tuesday evening; a

First Call

survey of only four analyst estimates predicts 18 cents per share, compared with 13 cents per diluted share one year earlier. After including a charge of 10 cents per share for altering an internal software system, the company reported 3 cents per diluted share in the year-ago period. (

As originally posted, this story failed to take a stock split into account when giving the year-ago earnings per share.

)

Mihaylo says he is comfortable with the analysts' estimates and that revenue for 1997 will exceed $220 million -- amounting to roughly $58 million in the final quarter. While its traditional phone products constitute the bulk of those sales, already Inter-Tel is planting the seed for Internet telephony.

In September 1997, Inter-Tel released its

Vocal'Net

product, a computer server that acts as a gateway between a corporation's phone system and the Internet. The Vocal'Net box slices a phone call's wavelike stream of audio signals into separate digital packets, then ships those packets over the Internet.