The Company That Caught Tom Gardner's Eye!

For Tom Gardner, it's never about the hot ticker, nor is it a stellar balance sheet, or even an enviable competitive advantage. For Tom, the investing ideas about which he is most passionate are the ones that go deeper than numbers. 

On a recent hunt for great stocks, the Fool's co-founder thumbed through the list of all the IPOs in the past year, and made a decision to focus first on insider ownership.

"Most of the companies that came public last year represent situations where executives are OUT-owned by their investors," Tom says. "I don't like this scenario for recent IPOs. Why did the company come public? Who is really calling the shots? Does the business have genuine and articulated long-term goals beyond the exit points for their primary owners? Blech. Didn't like most of them."

Who's the boss? And why?
With only a handful of companies passing that first test, Tom then started researching some non-financial factors. He concluded that the story -- the reasons behind a company's existence and the leader's presence in the organization -- is among the very most important elements of the examination of a potential investment.

"Look at a CEO like John Mackey, the founder of Whole Foods. Did he open his first store because he had a business plan and Wall Street funding and a dream of going public? No, he did it because he really believed in natural and organic foods, and he has lived his life that way." Tom thinks he has found another CEO in the mold of his favorites, people like Mackey, Jim Sinegal of Costco, and Howard Schultz of Starbucks.

The CEO in question is Carl Russo, founder and head of Calix (NYSE: CALX  ) , makers of broadband access equipment that lets phone companies deliver next-generation services to residences without expensive upgrades. He stumbled into a career in business after his mother died of leukemia -- his father was too distraught to run the family's electronics distributorship, so Russo abandoned his studies as a research physicist to take over the family business.

Years later, he snagged one of the highest prices ever paid for a privately held tech company in 1999 when he sold Cerent, his optical networking company, to Cisco Systems (Nasdaq: CSCO  ) for $7 billion. He spent a couple years with Cisco before, according to a BusinessWeek profile, he retired to race cars. No, really. But despite becoming a top contender in the Champ Car series in only two years, he sought out his next challenge.

Mastery at every step
From his investing to hiring at the Fool, Tom loves to find people who demonstrate mastery, figuring someone who has the discipline and drive to become a leader in one field can adapt to another. Russo found success in building his own business, generating huge sales increases at Cisco, racing cars, and then, with Calix, extending the mastery he gained at Cerent to turn around a failing company.

When Russo joined Calix, the company had just laid off half of its employees and was struggling in nearly every way. Today, less than a decade later, Calix is capitalized at roughly $1 billion and counts major players such as CenturyLink (NYSE: CTL  ) among its 900 customers. It raised $82 million in its IPO last March, and now boasts impressive top-line growth rates, increasing gross margins, $100 million in cash on the balance sheet, and no debt.

And Calix recently closed the purchase of its fierce rival Occam Networks, a move that makes competitive sense, according to technology analysts GigaOM. "As stand-alone companies, both Occam and Calix were too small and faced competition from much bigger rivals such as ADC Telecommunications [now part of Tyco Electronics]. They also had incomplete portfolios. This is a good combination and a great opportunity for these companies to vie for business from some of the larger broadband service providers who typically opt for the Alcatel-Lucents (NYSE: ALU  ) and Huaweis of the world."

Wait, don't buy yet
While all that sounds great, Tom's not ready to pull the trigger just yet. The fact that Russo created $7 billion of value with his previous company and that his new company is capped a little below $1 billion definitely makes this company worth watching ... but not yet a purchase.

"I'm not saying this is a buy. Obviously, valuations are running high across tech," he says. Plus, the stock is lightly traded, so there's definitely the possibility of significant swings in share price, as evidenced by Monday's fleeting drop of nearly 20%. "But this is exactly the sort of situation I like to find and add to my watchlist. I'm looking at companies like this across the marketplace, where a long-term leader has a big stake, there is healthy growth, a sound balance sheet, and then we dig in deeper. I love starting with ownership and leadership."

With one click, you can keep an eye on Calix as well, thanks to our free MyWatchlist service and daily digest, or you can start a new watchlist and add any company you want. Not only will you get valuable updates on Calix, but you also get immediate access to a new special report, "Six Stocks to Watch From David and Tom Gardner." Click here to get started or just type your email into the box below.

Roger Friedman owns shares of Starbucks. Costco Wholesale is a Motley Fool Inside Value selection. Costco Wholesale, Starbucks, and Whole Foods Market are Motley Fool Stock Advisor recommendations. The Fool has created a bull call spread position on Cisco Systems. The Fool owns shares of Costco Wholesale, and Starbucks. Motley Fool Alpha owns shares of Cisco Systems. The Motley Fool has a disclosure policy.


Read/Post Comments (3) | Recommend This Article (48)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On March 18, 2011, at 4:50 PM, hanover67 wrote:

    Is this another Activision?

  • Report this Comment On March 20, 2011, at 11:30 AM, TMFTomGardner wrote:

    Hanover,

    I'm not sure what you mean by that comment. Calix is in a completely different business than Activision.

    I'm guessing you've posted this because Activision has been a recommendation in our Stock Advisor service that's down about 35% since September 2008.

    It would be appropriate here for me to jump in and say that's my brother's recommendation. And I might even start mocking him a bit for it...except for this fact.

    His February 2003 recommendation of Activision is up 500%. And his August 2002 recommendation of it is up 200%. That makes the recent 37% downdraft look trivial.

    We're very long-term investors at The Motley Fool, at least measured by standards of a U.S. investor (who holds stocks for just 135 days, on average). We just don't see much opportunity to make much money worrying about stocks over a few weeks or months.

    Which is why I close this note by saying that I certainly hope Calix will be another Activision. I'd love a 500% return over the next 7+ years from it. And I think that return is definitely possible here. But I'll close by reminding you that Calix is just a Watchlist stock for me right now. I haven't formally recommended it.

    Best of luck with your investments.

    Tom Gardner

  • Report this Comment On March 31, 2011, at 12:14 PM, QuailRun53 wrote:

    I'd be concerned about fundamentals.

    Calix is in a market space with poor performance historically; companies that were in the space (Lucent, Nortel, Alcatel, Tellabs, to name a few) made little or no money with their access products and have exited that space. So I'm leery of the access market.

    Calix's situation is compounded by the fact that they've spent $100 millions to field their most popular product: the C7. In spite of having a lot of traction with 2nd and 3rd tier service providers (1000s of C7s deployed), Calix hasn't made anything more than token profits in 12 years.

    The C7 is also an ATM-based product when the entire telco world is madly shifting to ethernet. Calix has been trying to make the same shift with new product lines. They've had a handful of false starts getting that done internally while Occam has been a major thorn. Calix is pulling that thorn with the Occam acquisition gaining an ethernet based product. Now, they'll have to integrate 2 ethernet product lines (or discontinue the one that has yet to gain field acceptance) from 2 companies that, apparently, weren't doing well enough financially to remain independent.

    The question I haven't found an answer to concerns the moat that Calix has with its products.

    The C7 moat is high enough (based on proprietary hardware components) that they can and will offshore its future maintenance without concern about IP piracy. Maybe that'll increase their C7 margins or, also maybe, those aging, single-source proprietary hardware components will undermine margin gains with the offshoring.

    The Calix PON products are best-in-class. Their moat looks fine. And, if optical deployment to homes gains further momentum, Calix should do well there.

    I see their problem product is with their ethernet line(s). They HAVE to field an ethernet product, that product line must have good margins, it must be deployed by large service providers and it must have a high enough moat to fend off copy cat products. I've been trying to figure out how they pull that combination off. Ethernet products have an inherently shallow moat as evidenced by the flood of ethernet-based products in the market. How can Calix differentiate their products in a crowded market? If they fall back on a story that emphasizes "our network management product", they're using the oldest marketing smoke screen in telco (every company claims a world-class network management product).

    So I don't get how Calix differentiates itself from the pack going forward nor how they protect their future successes.

    OTOH, Carl Russo has pulled a lot of rabbits out of his hat. It would surprise me if he did it again (how many rabbits fit in that hat?) but I've been surprised every time anyway. Carl's modis operandi is shocking and surprising people so maybe...

    I see going long on Calix as a pure bet on the combination of Carl Russo plus Calix's positioning when it comes to federal stimulus money. While I can see where this is a good bet for speculators, I don't see that any fan of fundamentals would seriously consider taking that bet.

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