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Four VOIP Stock Favorites

 


By Hal Plotkin
Silicon Valley Correspondent

Several analysts say they expect to see IP-telephony stocks take over leadership in the telecommunications sector during the coming year, as both traditional long-distance phone companies and end users begin to make the transition from old-fashioned circuit-switched networks to the Internet-based phone systems of the future.

Although the first few firms to offer free Internet phone calls are experiencing runaway customer demand, industry experts often disagree as to whether a majority of consumers will want to make virtually free phone calls over the Internet, given concerns over quality and reliability.

Analysts Debate Merit of Free Net Calls

Few industry watchers, however, doubt the critical role IP-telephony technology will play within the telecom industry as traditional telephone companies continue to transfer more of their own network traffic to IP systems in order to compete on cost.

As a result, growth in both consumer and service-provider IP-telephony markets is expected to be explosive, with overall demand for IP-telephony services projected to grow to about $19 billion by 2004, from $500 million this year, according to International Data Corp.

“IP telephony is a large and fast-growing market,” says Cynthia Houlton, an analyst with Dain Rauscher Wessels in San Francisco. “We’re looking at something like 100 percent annual compound growth. That’s one of the reasons that makes these firms very good investments.”

“I don’t have any doubt about the importance of IP telephony as a trend,” says Mark Winther, group vice president for worldwide telecom at IDC in New York. “IP-telephony companies are reinventing the world.”

The analysts say the stocks of IP-telephony firms that help businesses and consumers make the transition to the new technology are best positioned to enjoy strong near-term upside moves.

“We’re probably not going to have IP telephones tomorrow,” Houlton says. “We may get to that. But in the meantime, what these companies are doing is bridging the gap between IP and circuit-switched networks. That’s where we see the real growth coming.”

As a group, IP-telephony stocks took it on the chin earlier this year, after the initial wave of giddy euphoria over the newly emerging sector subsided.

Adding to the sector’s woes, there are still far fewer financial analysts covering
IP-telephony firms, as compared with larger and more-traditional phone companies, which offer the securities firms that employ analysts greater opportunities for new business related to large-scale mergers, acquisitions and capital placements.

But the smaller group of analysts who do follow the still-nascent IP-telephony market say that could soon change as IP telephony gains momentum and attracts new business-hungry followers among Wall Street securities firms. When that happens, they say, the stocks of leading IP-telephony companies will get the boost that usually accompanies increased favorable attention from the financial community.

As a group, the IP-telephony analysts all say that current and projected IP telephony market share gains represent only the tip of the IP-telephony investment opportunity.

Over time, they say, the companies that control telecom traffic will be in the best position to grow complementary lines of business, including offering the full range of value-added telecom and perhaps even entertainment services.

“There’s another thing people don’t realize,” Houlton adds. “These companies are not building costly fiber-optic networks or things like that. They don’t have those kinds of expenses to worry about. It gives them a very significant competitive advantage.”

Here is a brief look at four leading IP-telephony stocks that analysts say could move higher during the coming months:

AudioCodes Ltd. {AUDC}
Analysts say Israel-based AudioCodes is emerging as a key platform, or sub-system, supplier selling signal processors, communication boards and software that compresses voice data into smaller and more-manageable packets to assist their more-efficient transport over IP networks. The firm’s improved data-compression technologies are one of the key factors that are beginning to bring IP telephony up to desired quality levels.

“We believe that AudioCodes is a pure-play pioneer in the ‘voice over anything’ market and as such continue to rate the stock a “buy,” wrote Robertson Stephens analyst Arun Veerappan in a recent research note reiterating his recommendation on the stock.

It is the versatility of AudioCodes’ products that most impresses analysts.

“AudioCodes is a key technology leader with the ability to continue to expand in multiple markets such as DSL [digital subscriber lines], cable and frame relay,” says Edward Jackson, an analyst at U.S. Bancorp Piper Jaffray in Minneapolis. “All of those markets are extremely attractive.”

Jackson currently has a “strong buy” rating on the stock, along with a 12-month price target of $164.

AudioCodes soundly beat our estimates in Q2 and appears to be well positioned to post another solid quarter in September,” Veerappan wrote. The analyst forecasts 2000 revenue growth of 124 percent and earnings growth of 103 percent.

Clarent Corp. {CLRN}
Redwood City, Calif.-based Clarent is seen as another key IP-telephony arms merchant.

The company sells Internet-based telephone systems and related software, sometimes called gateways, to telecom service providers, such as AT&T Corp. {T}, China Telecom and Japan’s NTT {NTT}. A majority of the firm’s sales have taken place outside the United States in recent quarters, in markets where traditionally high telecommunications costs create particularly motivated customers.

“Right now, there are more minutes of traffic going over Clarent [gateways] than any other competitor, including Cisco {CSCO},” Jackson says.

Jackson has a “strong-buy” rating on the stock, along with a 12-month price target of 115.

Jackson says Clarent’s stock got hammered earlier this year on concerns that price points for its hardware were coming down. “They got taken to task in the second quarter on that, but it turns out they did very well on the software side, which expanded well above expectations,” he says.

Clarent’s current stock price, Jackson adds, along with those of his other picks in the sector, give investors a nice shot at a sizable upside ride. “A combination of factors makes this a pretty good early investment opportunity,” he says.

iBasis Inc. {IBAS}
Based in Burlington, Mass., iBasis sells wholesale IP-telephony services to telecom carriers serving voice, data and fax markets. Analysts see the company’s stock as an arbitrage play because the firm’s technology allows its telecom-carrier customers to circumvent the often-high long-distance call-termination fees imposed in many foreign markets.

The company guarantees certain levels of quality to its customers and switches traffic between lower-cost IP and higher-cost dedicated circuits to maintain reliable service.

“IBasis is having good success selling something the carriers really need,” says Jackson says. “The carriers have to cut costs to stay competitive, which is what iBasis does.”

Jackson currently has a “strong-buy” rating on the stock, along with a 12-month price target of 70.

“I don’t think most people really understand what the longer term opportunity for iBasis is,” Houlton adds. “It’s not just about selling cheap long-distance services.”

Like the other analysts who follow the industry, Houlton says the real opportunity will present itself down the line, after firms such as iBasis have captured a larger slice of digital telecommunications traffic. Once that happens, she says, the firm will have a captive audience to which it can offer a wide variety of value-added services, such as the ability to get your voice mail delivered over the Internet, or to combine data, fax, voice and other information services in a variety of product configurations.

“We might have to wait until they deliver on some of those value-added services for more people to get it,” Houlton says. “But I think we’ll begin to see some of that traction later this year to early next year.”

The analyst has a “strong-buy” rating on the stock, along with a 12-month price target of 55.

Net2Phone Inc. {NTOP}
Hackensack, N.J.-based Net2Phone was one of the first companies to allow consumers to make cut-rate calls to any phone in the U.S. using their computer. The company was founded in 1997 as a subsidiary of long-distance carrier IDT Corp. {IDTC}. More recently, AT&T led a consortium of investors who are pumping an additional $1.4 billion into the firm, with about $300 million of it coming from AT&T.

“Net2Phone has partnerships with some of the biggest brands out there,” Houlton says, referring to deals the company has with firms such as AT&T, Microsoft Corp. {MSFT} and Yahoo! Inc. {YHOO}. “They are in a leadership position, and have plenty of capital to expand operations and fend off losses in the near term. That minimizes the downside risk.”

Houlton has a “strong buy” rating on the stock, along with a 12-month price target of 81. She says the company’s hybrid approach, which uses both personal computers and old-fashioned telephones, makes it a classic example of an IP-telephony bridge technology.

“The fact that AT&T is willing to pay $75 a share and buy 4 million shares really validates voice over IP,” adds Richard Juarez, an analyst at Robertson Stephens, in San Francisco.

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