Adtran: Plenty of Value Remains

NEW YORK (TheStreet) -- Carrier spending, or lack thereof, continues to be the major growth culprit among telecom stocks. While I believe Adtran's (ADTN) management has exceeded all expectations relative to the industry's struggles, investors have demanded more. And this is despite the company having reversed 2012's stock loss of 34% with 40% gains last year.

Adtran's strong performance last year wasn't easy. Although the likes of Verizon (VZ) and AT&T (T) have loosened their purse strings to reinvest capital back into their infrastructure in an effort to win some of those deals, competition from Cisco (CSCO) and Ciena (CIEN) also inched up several notches -- to the extent that Cisco was willing to sacrifice some margin.

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Despite these threats, Adtran's management consistently delivered strong profits, helped by above-average gross margin and operating margin. This indicated how strongly positioned its products were even amid Cisco's pricing pressure. Investors took for granted the manner in which Adtran was able to offset the recent slowdown while bigger names like Juniper (JNPR) and F5 Networks (FFIV) dropped off the grid.

With Adtran shares trading at price-to-earnings ratio of 41, more than 3 times that of Cisco, it's hard to make the "value" argument now. In fact, there are some analysts that believe the stock is destined to fall. But even if that were to happen, I don't see any fundamental reason to assume the decline would be anything other than profit-taking. I wouldn't blame investors for this. It's hard to pass up.

Adtran still possesses the ability to leverage its technological advantages to grow. The thing to remember here is that management has never been shy about taking innovative risks to grow its bottom line. As long as that culture exists, there's no question that Adtran is perfectly positioned to capitalize in carrier spending and overall enterprise IT.

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On Wednesday, management will need to sell the Street on Adtran's long-term prospects by offering encouraging guidance. I believe this is the only way to avoid a near-term sell-off, regardless of the numbers. The Street will be looking for earnings-per-share of 14 cents on revenue of $159 million, which would represent year-over-year revenue growth of close to 14%.


Management already offered some caution in the October quarter by guiding revenue down by $6 million more than initially projected. There's a chance that the Street may yet be too optimistic with its revenue demands. That, however, is a byproduct of an expensive stock, priced to outperform. This is where investors have to reconcile exactly what they are paying for. In other words, patience is necessary.

While I can't begrudge investors for their caution, it shouldn't be discounted that Adtran's management has continued to look for leverage and ways to exploit the carrier-spending rebound by launching several new services, which are aimed at empowering its customers and partners to choose their service delivery needs.

It's encouraging that the company has gotten a bit more aggressive. And as I've said, this was one of the reasons Adtran's margins held up well amid Cisco's price cuts. To the extent that this new portfolio of services is successful, Adtran might have uncovered a new growth segment. Here, too, the company is showing no signs of complacency, while looking for ways to differentiate itself.

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Given the rate at which Cisco and Oracle (ORCL) have been picking off companies, it wouldn't surprise me in the least to learn that Adtran was on their radar, especially given Adtran's recent gross margin and operating margin improvements. Something to keep an eye on.

For now, Adtran is undoubtedly one of the better operating companies within the telecom space. With the company's mix of equipment, communication services, and pricing strength, these shares still have 15% upside potential on the basis of improved carrier spending, which pushes its fair market value to $30 by the second half of the year.

At the time of publication, the author held no position in any of the stocks mentioned.

This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.

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