Why Oracle Overspent on Acme Packet

Shares of Acme Packet (UNKNOWN: APKT.DL  ) have surged 68% over the past three months since reaching a low of $15.31 in late October. Clearly investors were placing huge bets ahead of the company's Q4 earnings report released Monday. But what they got was a surprise buyout by Oracle (NYSE: ORCL  ) for $2.1 billion. And with telecoms ravaged by poor carrier spending, it's not yet clear that Acme Packet deserved this premium.

Absent clear signs that spending will rebound, it doesn't justify the optimism in Acme Packet. Besides, with a P/E ratio well over 300, it's fair to ask where the value is. Although Acme Packet has a sizable lead in the session delivery market, it pales in comparison to Cisco, which has a superior portfolio. And for value investors, Cisco also comes with much less risk.

Disappointing fourth quarter, but it's Oracle's problem now
While the Q4 report would have been the perfect starting point to this relationship. Acme Packet's results made me question whether or not Oracle truly knows what it's getting itself into. Granted, Acme Packet issued a warning to investors that the results would be light, saying revenue would arrive in the range of $84 million to $86 million, with earnings coming in at $0.26-$0.28 per share.

Granted, both targets were well below Street estimates. But the numbers were consistent with the outlook given by rivals. I was nonetheless shocked by what the company actually reported. Revenue dropped 15% year over year to $70.7 million. This was well below the low end of the company's own revenue estimates of $84 million. Never mind that it missed the consensus projections of $93.4 million

Non-GAAP net income dropped 64% to $6.5 million, or $0.09 per share. Essentially, not only did Acme Packet miss its own prior EPS estimates by 65%, but the company managed to also miss revenue estimates by 16%. Now these are pretty wide margins of error -- even for a lemonade stand.

Then again, not much was expected seeing as carriers have yet to open their wallets, which was evident in ADTRAN's fourth-quarter earnings report. The good news for Acme Packet is that Adtran's results were broadly in line with estimates with earnings arriving at $4 million, or $0.06 per share. Then again, for Adtran, both net income and revenue dropped 87% and 20%, respectively.

By comparison, Ciena (NYSE: CIEN  ) didn't woo the Street with its 2% revenue growth, but unlike Acme Packet, there is evidence that the company has begun to turn things around. Despite Ciena's soft report, shares jumped 5%. For Ciena, its solid fundamentals continue to reassure investors of its sound management.

Essentially, the Street believes Ciena's soft numbers were the result of macro conditions and not a lack of execution. That's not the case with Acme Packet. Plus, the Street was pleased with how Ciena performed categorically, including 66% growth in carrier Ethernet service delivery, or CESD. Likewise, service revenue soared 21%. And even with the half-point-drop in gross margin, it rose sequentially by over 3 points.

Essentially, in Ciena's situation, it's hard to punish the company for reporting earnings that merely arrive in-line with estimates, particularly in tough macro climates. However, when the stock carries a valuation multiple 20 times the industry standard, as Acme Packet does, the scrutiny is warranted -- especially when cheaper rivals outperform.

Then again, it's reasonable to suspect that Acme Packet knew the importance of its guidance as it was negotiating its deal with Oracle. Guiding too low would have sent investors into a panic, potentially shedding valuable negotiating leverage. On the other hand, there's no way Oracle would have done this deal without prior due diligence. Oracle is too smart.

For that matter, there are a couple of ways to assess this deal. Either Oracle sees an imminent sector rebound and feels there's too much unrealized value in Acme Packet, or it's a defensive move, aimed at keeping Acme Packet out of the hands of another rival. But what does Oracle know about networking?

Can the Net-Net 6300 help fight off the competition?
Another concern for Oracle and Acme Packet will be the increased competition from Alcatel-Lucent (NYSE: ALU  ) , which has recently been given new life. Alcatel-Lucent has seen its shares spike upward, partly because the company is no longer facing concerns related to liquidity after having secured a $2.1 billion financing pact.

This new financing will help Alcatel buy time while it seeks out some new business that might develop when the industry fully rebounds. However, working in Acme Packet's favor is that the company has new technologies such as the Net-Net 6300 that should help stimulate growth over the next couple of years. Whether or not this can fend off more prominent names such as Cisco remains to be seen.

Nonetheless, it should help Acme Packet fight smaller rivals like Ciena and Alcatel-Lucent. The Net-Net 6300 is able to supply customers with high-capacity network communication between service providers. The device plug-and-play and also offers large-scale subscriber access environments such as VoLTE.

What's more, it supports one million subscribers and has the capability of handling 200,000 simultaneous calls. In other words, this has game-changing potential for carriers as they begin to switch to session initiated protocol trunking, Acme Packet's main area of expertise. CEO Andrew Ory recently described the Net-Net 6300 this way: "It improves our capabilities to meet the needs of our customers in three areas: for high-capacity network interconnect between service providers, for large-scale subscriber access environment, such as VoLTE, and for large-scale contact center and enterprises."

There's no question that this should help Oracle and Acme Packet preserve market share. But to what extent can the Net-Net 6300 help Oracle acquire more business and produce the growth that investors are paying for? Prior to the acquisition, analysts were projecting Acme Packet to grow at a 12.5% rate over the next five years. Will it be enough for Oracle?

A too-pricey premium
For as brilliant as Oracle has shown to be over the years, it's too early in the game to start second-guessing its decision to buy Acme Packet. But the Q4 results were too horrible to warrant the premium that Acme Packet received. Also, while I'm not going to cry foul play here, I'm nonetheless flabbergasted that Acme Packet's management was able to miss this badly on guidance. I believe Oracle knows exactly what it's getting itself into with this deal. But I'm not so sure investors of Acme Packet realized what just happened.

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12/31/1969 7:00 PM
APKT.DL $0.00 Down +0.00 +0.00%
Acme Packet CAPS Rating: ***
ORCL $46.00 Up +0.65 +1.43%
Oracle CAPS Rating: ****
ADTN $21.93 Up +0.10 +0.44%
ADTRAN, Inc. CAPS Rating: ***
ALU $3.60 Up +0.01 +0.28%
Alcatel-Lucent (AD… CAPS Rating: ***
CIEN $19.36 Up +0.09 +0.47%
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CSCO $27.77 Up +0.12 +0.43%
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