By Paul Larson (TMF Parlay)
April 6, 2000

Redback Networks Inc.

Ticker: (Nasdaq: RBAK)
Phone: 408-543-2100
Website: www.redback.com
Price (4/5/2000): $121

How Did It Double?

Companies that have been supplying the Internet boom have been hot, and one company that exemplifies how richly investors value networking hardware stocks is Redback Networks. At this writing, the stock is trading at nearly 300x sales. An insane valuation, right?

Perhaps not. Redback is the leading supplier in one of the networking industry's fastest growing sectors -- subscriber management systems. These are essential systems for companies looking to deploy high-speed broadband networks, and Redback controlled roughly 77% of the broadband subscriber system market in 1999. Demand for these products is expected to increase more than 10-fold over the next three years, generating anticipated market-wide sales of somewhere near $5 billion in 2003.

Investors who are bidding up Redback undoubtedly are looking at Redback's impressive positioning within its niche and the explosive potential of its particular market. Even after the recent tech-stock washout on Wall Street, most Redback shareholders are still nowhere near being in the red. The stock is now up more than 20-fold since the company's May IPO and has split 2-for-1 twice in the past year.

Business Description

Based in Sunnyvale, California, Redback Networks is a leading provider of advanced networking and communications products. The company's Subscriber Management Systems (SMS) product line connects and manages large numbers of subscribers using any of the major broadband access technologies, including cable, Digital Subscriber Line (DSL), and wireless. The company's primary customers are telecommunications firms and Internet service providers that are looking to scale their networks.

The company was founded in 1996 and came public in May 1999. On March 8 the company completed its merger with privately held Siara Systems in a stock-swap deal that found Redback issuing a split-adjusted 62.7 million shares for the purchase. Siara is a development-stage company that is also researching and designing next-generation network hardware.

Redback Networks split its stock 2-for-1 on April 4.

Financial Facts

Income Statement
12-month sales: $64.3 million
12-month income: ($37.1 million)**
12-month EPS: N/A
Profit Margin: N/A
Market Cap: $18,265.2 million

Balance Sheet (as of 12/31/99)
Cash: $57.2 million
Intangibles: $4,461.6 million
Total Assets: $4,558.0 million
Long-term Debt: $11.4 million
Total Liabilities: $64.8 million

Ratios
Price-to-earnings: N/A
Price-to-sales: 284.1

*Figures are pro forma to the Siara merger
**Before amortization of intangibles

How Could You Have Found This Double?

Unless one was familiar with networking hardware or really tuned-in to the IPO market, Redback would have been a fairly difficult company to find. The company's systems are, to say the least, not exactly consumer products. Moreover, Redback was a fairly small niche player in the overall networking world until recently. That said, there are always ways to find companies like Redback.

One way would have been to look at the company's high valuation and relative strength. While it may be counterintuitive to search for companies with lofty price tags that have already run up, it is nevertheless a great place to find Rule Breaking companies. Wall Street may not be perfectly rational, but it rarely bids companies up for no reason. When a company seems to have a valuation that is out of whack at first glance, it's often good to take a closer look at the underlying fundamentals to see what all the fuss is about.

Where to From Here?

Redback may be the current market leader for subscriber management systems, but it will be facing increased competition from some of networking's largest gorillas. Both Cisco (Nasdaq: CSCO) and Nortel (NYSE: NT) are making major moves into Redback's domain, and Redback can't feel too comfortable being in Cisco's crosshairs. It's certainly worthwhile for investors to keep a close eye on Redback's competitive landscape to see how its products stand up to that of its peers. Redback appears to have the current technological lead, but things can change quite rapidly in this field.

Of course, competing with Cisco is not always a bad thing. In the past, Cisco has proven itself more than willing to pay up for companies with complementary products or technologies in order to improve its system portfolio. It is within the realm of possibilities that Cisco, Nortel, or even Lucent (NYSE: LU) would be interested in purchasing Redback in order to get their hands on some of the company's technological expertise.

Redback has also proven itself willing to pay seemingly exorbitant amounts for smaller upstart companies with hot prospects. The Siara purchase was a $4 billion deal when it was announced (much more now that Redback's stock has run up), and Siara does not have a single dollar in trailing sales. What Siara does have is a nifty solution that will allow both voice and data traffic to coexist on the same network, which is definitely a worthwhile technology, especially when combined with Redback's current product offerings. It would not be surprising to see Redback continue to use its strong stock currency to gobble up some of its smaller networking peers.

Needless to say, much of the optimism about Redback's future is already built into the stock price at today's levels. On the other hand, continued breakneck growth is nearly guaranteed for the next year or two. Either way, Redback is an interesting little networking company worth keeping on the radar.

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