Veraz Vanquished

There's no way to put a positive spin on the Veraz Networks (Nasdaq: VRAZ  ) IPO. The company dropped the pricing on its offering from a range of $10-$12 down to $8, but that still wasn't enough. In subsequent trading, shares slid 2.5% to $7.80. Investors are concerned about the competition and the company's transition from an older product line.

Veraz has two main businesses. Its legacy digital circuit multiplication equipment (DCME) business compresses voice and fax traffic. From 2004 to 2006, revenue here has shrunk nearly 20%, to $38.5 million.

The Internet protocol (IP) products are a much more fashionable business. These systems help telecom companies move data across traditional and IP networks, allowing them to offer additional revenue-generating services such as prepaid calling and voice-over-Internet-protocol telephony.

Veraz has been aggressively selling its IP products to its large customer base of more than 400 DCME customers. Revenues from IP products nearly doubled last year, to $47.3 million.

It's a smart strategy, but it still resulted in a net loss of $13.9 million in 2006. Veraz must continue to support two product lines while pumping up R&D. Last year's R&D expenses surged 22.7% to $26.5 million, representing a stunning 32.7% of total revenues.

But management has no alternative. R&D is critical, since the company faces competition from Alcatel-Lucent (NYSE: ALU  ) , Cisco (Nasdaq: CSCO  ) , Nortel Networks (NYSE: NT  ) , and Siemens (NYSE: SI  ) .

Veraz has given itself some breathing room by selling into emerging markets such as Brazil, India, Indonesia, Pakistan, Russia, and Vietnam. While these markets are hungry for telecom equipment, it's only a matter of time before competition intensifies in these regions as well.

The other unknown is the rate of deterioration in Veraz's DCME segment. Any sudden drop could wash out much of the growth in the IP business. It's a serious risk, and it may continue to weigh down on the stock for some time.

Further clearly audible Foolishness:

Fool contributor Tom Taulli, author of The Complete M&A Handbook, does not own shares mentioned in this article. He is currently ranked 2,719 out of 25,386 in CAPS. The Fool has a disclosure policy.

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