Opinion on  Openwave Systems Inc (OPWV)     Sector: Technology  >  Industry: Software & Programming
Bullish on OPWV ...

OPWV: short term panic creates long term buying opportunity

OPWV has seen large percentage decline in share price. I would like to highlight why current share price is a bargain if you hold a long term view. The sentiment in the tech land is brutal. Tech is a least favored sector as investors worry about state of the economy and slowing momentum in earning prospect of tech companies as Fed continues with its rate hiking campaign. The money had flown out of tech land and into commodity and energy. However, with recent nasty correction in the market, liquidity is even flowing out of highly speculative commodity and energy and a lot of cash is staying on the sideline. In my opinion, as long as Fed does not overtighten, earning growth in the tech companies will be robust especially, for those with exposure to tech infastructure market as American corporates are sitting on record amount of cash to improve business efficiency.

Earning guidance and option expense issues weighs on the stock.

Two factors are currently depressing the OPWV share price. One is limited guidance for the future earning. You recalled that OPWV stock ran into same issue last year when the company management team failed to provide the next Q guidance, bringing down the share price from $22 to $14. During the last conference call, the management team said that the revenue number for next Q is somewhat unpredictable due to issues related to timing of a few large system deals. Impatient momentum investors were all over these issues, dumping the shares. However, if you look at the business trend in the wireless software market, you have to expect that lumpiness of the revenue number on a quarterly basis.

Long ago, wireless software vendors were often specialized in one particular types of software. Carriers such as Verizon and Sprint prepaid for the software according to their forecasted demand. The companies recognized the prepaid software as revenue so they had a better idea how the revenue is tracking quarter to quarter. Today software vendors no longer provide single software to the carriers. In fact, there have been huge waves of industry consolidation and many perished and merged. Now the wireless software companies provide system solutions, selling suites of platforms and service to implement the solution over the wireless network. Thus, OPWV evolved from being a single gateway (WAP) software provider into platform vendor which bundles infrastructure software, messaging solution, phone browser, as well as broadband connectivity solution into one common system platform. Recognizing the revenue of this complex business deal is not that straight forward as the company needs to meet specific milestones for timing of revenue recognition. This is why the company refuses to comment on the Q to Q revenue guidance. Rather the company provides the annual guidance and we are continuing to see management’s confidence to grow the revenue on an annual basis.

Another factor that is weighing on the share price is option expense investigation inquiry by SEC. News of SEC looking into OPWV option expense practice from 1997 to 2001 is causing shortsellers to come out and have a party. I believe this party is not likely to last long. From recent investor conference call, the management continues to iterate strict protocol the company follows with respect to SEC guideline when dealing with option expenses. In addition, the period of SEC investigation is for the previous management team and has no bearing on current outlook of the company or the business ethnics of the current management.

Overwhelming positive catalysts

The business outlook for OPWV continues to shine in my opinion. The carriers are faced with very tough business conditions. Their wireline business is dissipating. The wireless voice business is seeing tremendous competitive forces and pricing pressure. They really need to boost the wireless data business in order to show growth in their business. They have spent massive amount of money to upgrade their infrastructure to 3G network for faster data transmission; yet 3G has been a bust for many of these companies. The reason is lack of content. People in the US are still very hesitant to do anything else with the cell phone other than talking. People don’t like to scroll down and push too many buttons when it comes to cell phone. Industry is in a bad need for simple elegant solution for people to send data, get contents, and communicate over carriers’ wireless network. OPWV is at the heart of this trend. The company continues to rack up impressive software solutions to simplify wireless data experience. On top of the wireless software solution, the company recently entered into music downloading business via acquisition of Musiwave and last Q, the downloading business has shown larger than expected growth in the revenue.

Cheap valuation with respect to earning power.

The company backlog number continues to balloon over 122 mil last Q. The company has shown 8 quarters of growth on a year to year basis. Book to bill continues to remain above 1, showing order momentum. The restructuring charge associated with previous downsizing efforts and acquisition of Musiwave is now completely removed going forward. This will really clean up earning picture on GAAP basis. IN addition, the gross margin continues to track above management guidance above 71%. And the op ex number is showing sign of improvement and the management is aiming for 18% to 20% by the end of this year. I have no doubt in my mind that the company will be able to achieve 500 mil revenue run rate at the end of this year with op ex number close to 20%. This will generate 100 mil net profits on an annual basis. EPS could surpass $1.1 based on 93 mil shares outstanding. At today’s closing price, PE is less than 12 (cheaper than some bank stocks). When the company shows that the revenue growth will be consistent on an annual basis and the tech market receives higher multiple, OPWV could command PE of 20 to 25, taking the share price close to $30.

Conclusion

Short term momentum traders and impatient investors have given the gift to long term investors

OPWV shares tumbled to $7 and a change after trading as high as $25 intraday just three months ago. This was a classic example of ¡°crash and burn¡±. I can sympathize with your pain if you hold significant number of OPWV shares. I had re-introduced OPWV into tech holdings at around $15 after recommending sell at around $20 to $21 level. At one point OPWV has been a 10X winner for us, rising from low $2 to low $20 in 2 and a half years. But my second call at $15 was completely blown one and I am sorry for that. Now, let us discuss whether OPWV is worth pursuing or we should cut the loss and move on.

Telecom spending picture too complex for current management team to understand

I have listened to the conference call. If you are just angry for losing money and hear management say ¡°unpredictable order pattern¡± over and over again, you wonder how the hell these guys became CEO and COO. After all, it is their job to forecast revenue and align proper amount of resources to maximize company profit (and they get paid big time!). The truth is that OPWV is facing radically different business landscape in the telecom industry. First, there have been waves of mergers between telecom carriers. Sprint and Nextel merged last year. So have Cingular and AT & T. There have been several mergers in Asia and Europe as well. This resulted in decreased number of customers and larger revenue dependence on a single customer. Now OPWV faces only a few customers who are asking the company to provide end to end solutions (not just software but complete integration of software on their hardware platform). This is a radical change as OPWV had myriad of companies to which the company just sold software platform. In other words, before OPWV had 100 companies to which it was selling 5 to 6 million worth of software. Now it is left with 20 to 30 customers which are asking 20 to 30 million $ integration work. So the revenue recognition becomes extremely lumpy for OPWV. In one Q, you could have several customers signing the contracts while in another, you may not have any. In addition, customers could defer paying OPWV until OPWV finishes all the integration work so revenue recognition is another challenge.

Telecom carriers becoming stingier with their purse

While revenue opportunity with one telecom carriers are heading up, telecom companies are demanding more work for fewer pay from OPWV. While it is asking more software sales in more extensive areas from platform to integration, it is asking for lower price on each item. Thus, OPWV software is becoming rapidly commoditized. This was evident from the next Q guidance. If you exclude Musiwave business of 7 to 8 mil for next Q, the company is seeing 82 to 84 mil from the core software business (client and server side). Unfortunately, this is same revenue level as the core software sales a year ago. This implies hardly any organic growth in the core business. Analysts are asking why the company is not seeing organic growth in the core business in the wireless side during the conference call. Well the company products are commoditized; revenue will remain flat at best in spite of the increased volume of your products.

Additional downward pressure from uncertainty in SEC stock option investigation

On top of the management¡¯s inability to outline more concrete revenue outlook, the company was recently subpoenaed by the SEC for investigation for inappropriate stock option grant practice. Although currently this has put downward pressure on the stock, I believe ultimate resolution of the matter on this front could help the stock to recover somewhat from this level.

Is there any bright side with OPWV?

The company still had excellent booking of 125 mil which means book to bill ratio of higher than 1.3 for the next Q. Also backlog will now swoon to higher than 250 mil in July. This indicates the company does have reasonable business outlook for investors to still have hope. Higher booking trend also implies the company revenue shortfall is likely to be contributed to timing of the revenue recognition from a few large customers and once these deals come into the revenue recognition pipe eventually, the company EPS should grow back to the normal level. Another business catalyst could come from Musiwave (music downloading business) which is expected to pick up although the revenue from Musiwave decline Q to Q for July Q. On the other hand, the company¡¯s large dependence on the system deal with a few large customers can easily translate into the sharp reduction in booking once the more competition emerges.

Valuation

The company guides more 58 to 62 cents for fiscal year 2007. I suspect this guidance is on the conservative side given more uncertain outlook. I believe that there could be 10% to 15% upside surprise if the company executes on the bottom line efforts. So taking 72 cents EPS with PE of 15, I see the stock valued fairly a round $11. ON the other hand, if you take gloomier look with 55 cents EPS with rock bottom PE of 10, the stock could trade as low as $5.5. SO if you believe in the company booking and backlog story and want to buy, give plenty of safety room and buy only when the stock dips slightly below $6.

Conclusion

OPWV at $15 was a blown call. I am downgrading the stock to HOLD with the revised target at $11 from $28. If you feel aggressive, buy the stock below $6 as the valuation supports there. Backlog and booking trend favors the probability that the company will eventually come back. As such, I will not assign Sell rating. I will monitor the stock carefully to see if OPWV could come back to $23 level again. If it does, it could be a huge winner for us. But wait for things to clear.