Daily Double
October 25, 1999

Harmonic, Inc.

Ticker: (Nasdaq: HLIT)
Phone: 408-542-2760
Website: www.powerwave.com
Price (10/22/99): $66 1/2

By Paul Larson (TMF Parlay)

How Did it Double?

With the explosion of high-speed Internet services, many of the companies that are supplying the boom have seen their stocks perform exceptionally well. One of those companies that has benefited by the money being thrown at upgrading the nation's cable franchises by the likes of AT&T (NYSE: T), Microsoft (Nasdaq: MSFT), and Paul Allen's Vulcan Ventures is today's Daily Double, Harmonic Inc.

Over the past several months, Harmonic investors have had nothing but outstanding news. Beyond producing what many consider the "best of class" infrastructure equipment for broadband networks, the financial picture of the company has also taken a definitive turn for the better. A quick look at the most recent results shows exactly why investors have been bidding the stock up:

                 Q3 1999   Q2      Q1    Q4 1998
Sales             $52.6M $37.9M  $30.3M  $27.1M                  
Net Income         $7.7M  $3.9M  $1.3M    $0.6M
EPS                $0.23  $0.13  $0.05    $0.03
Gross Margin       43.9%  42.2%  41.0%    38.4%
Operating Margin   17.7%  11.6%   5.8%     2.2%
Net Margin         14.6%  10.3%   4.3%     2.2%

With the financial trends all heading in the right direction and continued fundamental growth expected, it's no wonder that Harmonic's shares are riding high. Trading below a split-adjusted $5 a share at this time last year, the stock essentially has gone the same direction all year long -- up.

Business Description

Headquartered in Sunnyvale, California, Harmonic manufactures and sells fiber-optic transmission equipment for cable, satellite, and wireless systems. These broadband products allow an enormous amount of data, including video and audio, to be moved across networks. The end uses of Harmonic's products include telecommunications, high-speed Internet access, video-on-demand, and a myriad of other interactive services.

Cable companies are the most voracious consumers of Harmonic's equipment. AT&T (NYSE: T), now the largest cable operator in the country, alone was responsible for roughly half of Harmonic's sales in the most recent quarter.

Harmonic came public in May 1995 and had a secondary offering of 2.8 million shares in April of this year. The company also had a 2-for-1 stock split on October 14.

Financial Facts

Income Statement
12-month sales: $147.9 million
12-month income: $13.5 million
12-month EPS: $0.44
Profit Margin: 9.1%
Market Cap: $2,421.7 million (32.836M shares)

Balance Sheet
Cash and Equivalents: $52.8 million
Current Assets: $121.4 million
Total Assets: $158.5 million
Current Liabilities: $33.2 million
Long-term Debt: None

Price-to-earnings: 160.3x
Price-to-sales: 16.4x

How Could You Have Found This Double?

Looking at the market in which Harmonic operates, one couldn't help but notice that all the money being spent to upgrade the cable infrastructure for the Internet had to go somewhere. Predicting growth in all types of broadband applications was a lay-up, and those looking for the companies supplying that equipment might have found Harmonic early.

Another way to have profited from Harmonic was to simply look at the financial trends. Companies like Harmonic that have expanding margins and a vibrantly growing top line have an explosive profit mixture. One can often get some excellent investment ideas from looking at a screen of companies that have increasing margins.

Yet another screen that had Harmonic blipping loudly on it was the beat estimates screen. It's usually a sign of strength when a company can best the earnings expectations of Wall Street analysts.

Where to From Here?

Predicting further growth in the company in the near term is a fairly safe bet. Harmonic is positioned nicely to benefit from the continued rollout of high-speed Internet access both domestically and abroad. AT&T has invested quite a bit in upgrading its cable networks thus far, yet the bulk of the capital spending is still ahead. In addition, the demand for bandwidth of all kinds continues to grow rapidly, and those that feed society's hunger for moving more data around at faster speeds are set to benefit.

That said, potential investors are advised to spend a bit of time researching Harmonic's products and its target market. METROLink and PWRBlazer II may be products that make network engineers salivate, but the average investor probably doesn't have a clue what "multiplexing nodes" are. Unless one is really on top of the newest network technologies, further study of Harmonic is warranted.

Looking at the company's valuation, it's fairly obvious that Wall Street has already found Harmonic. The firm's future looks bright, and the stock's price reflects much of that optimism. As of this writing, the company is expected to earn $0.86 per share next year, which puts the stock right at 85x forward estimates. Any way you slice it, that's an expensive valuation and shows that investors expect cash flows to grow dramatically in the years to come.

The bottom line is the Harmonic has a bright future that is largely already reflected in the stock price. The easy money has already been made with Harmonic, but the company is probably worth keeping on the radar in case Mr. Market gets in one of his depressive moods and marks down the stock price or the company kicks its growth rate even higher that it already is.

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