The credit crunch has helped cause the bursting of several bubbles during the past year. The unwillingness of banks to lend to each other and to the rest of us has played its part in the bursting of such bubbles as the oil bubble; the housing bubble; and (now that the biggest bubble of all, the Chinese bubble, is starting to wobble) the commodities bubble.
Plenty of investors were caught out. But one wonders how we could have been so daft as to believe all the nonsense we were spun over the past few years about how “this time it is different!”
Clearly something in the human psyche wants to believe that such phenomena as “commodities super cycles” or “a structural shortage of housing in the UK” will lead to ever-increasing prices. But it is a shame we investors learned nothing after the last great bubble, the technology bubble, which burst only eight and a bit years ago.
Back then, as now with the banks, even FTSE-100 constituents and household names (e.g. Marconi) went to the wall. But this writer remembers well the advice that companies selling the “picks and shovels” into the dot.com and telecommunications “gold rush” were best placed to survive if not thrive.
One such company was Spirent Communications and, though its shares may not have thrived since the technology bubble came to an end, the business did at least survive.
In the autumn of the year 2000 Spirent’s shares were trading for around 16 times their current share price, as the firm entered the FTSE-100 and also made two acquisitions designed to bolster its position as a leading telecoms testing equipment manufacturer.
But by the end of 2007, the group had become a middle-ranking FTSE-250 business and had seen its annual revenues fall to £237m from £802m in 2001. Over the same period Spirent’s pre-tax profits fell from £101m to £17.8m.
Part of the reason for this substantial fall in revenues and profits was the disposal of the group’s HellermannTyton network products business in February 2006, for which Spirent received almost £300m. These proceeds were used to repay the group’s debt, fund its pension scheme and buy back up to £50m of shares.
As well as significantly improving the group’s financial position, the sale of HellermannTyton was also designed to transform Spirent into a focused communications business, continuing to carry out its core activity of supplying blue chip companies like Cisco, Alcatel-Lucent and AT&T with performance analysis tools and network diagnostic instrumentsm, as well as with related software and services. A year-or-so after the sale, the group’s management had put in place plans to target areas of strategic advantage, while also achieving costs savings of more £28m.
Thanks to Spirent’s strategic review its revenues, after slipping further in 2007, began to recover in 2008. But the focus on cost savings had a huge positive impact on pre-tax profits, which jumped 179% last year to £49.6m.
Perhaps more importantly, Spirent’s restructuring has led to gains in market share. But how the economic downturn is expected to affect the group appears to be something of a mixed bag.
According to Spirent’s management, current conditions are forcing network equipment manufacturers and network service providers to have another look at the way they do business, and they are increasing their focus on driving efficiency and operating even more cost-effectively. But these equipment makers and service providers also recognise that they need to invest in technologies in order to compete in global markets, especially since the pervasive nature of the Internet on all sorts of platforms (computers, mobile phones, television and other devices) is driving growth in traffic, demand for higher speed access and network complexity. So, this investment in next-generation technologies is expected to continue to drive the need for test systems and services.
Meanwhile, there is the shorter-term dynamic of the economic downturn leading equipment suppliers to focus on increasing efficiency in their research and development activities. This, in turn, will drive demand for more automated systems, professional services and expertise to assist in automation projects – all of which are important sources of revenue for Spirent.
For 2009, Spirent looks like it will be affected by weakening trends. City broker UBS says that the group will “not prove to be immune” from a slowdown affecting its key customers: original equipment manufacturers. But the bank also points out that such factors as management driving cost savings (including further savings of £8.2m in Q1 2009) and exposure to growth areas (e.g smart phones and GPS) mean the shares are worth buying up to a price of 80 pence each.
For this year, UBS estimates that Spirent will deliver revenues of £276m (2008: £258m) while adjusted pre-tax profits are expected to decline 17.5% to £38m. But given that the current share price is rated at only 8.5 times estimated earnings per share (adjusted for goodwill and exceptional) of six pence for 2009, not to mention the 7.5 pence cash per share on the group’s balance sheet, it is easy to see why UBS rates Spirent a buy.
Rival broker Cazenove is more bullish with its forecasts, estimating a slight increase in profits with adjusted EPS expected to come in at 6.7 pence this year.
Beyond 2009 the brokers have differing views on Spirent’s revenue growth, with Cazenove expecting a 7% decline in turnover in 2010 while UBS expects a small increase. Both agree, however, that earnings will be lower next year.
That means there may be time for investors to get in at a lower price. One thing is for sure, though: no matter how bad the economy gets, multimedia communications is here to stay and those firms that play a part in making it work still need to test their equipment and networks. Spirent’s shares may not ever again reach the dizzy heights achieved at the start of this decade, but it clearly does not need another tech bubble for it to achieve solid growth in years to come.