DragonWave (Nasdaq: DRWI) is a Canadian-based backhaul wireless provider, and with a $192 million market cap, it's one of the smallest of its bunch. It competes with another small-time player, Ceragon Networks (Nasdaq: CRNT), but the majority of other backhaul equipment providers include billion-dollar Alcatel-Lucent (NYSE: ALU) and LM Ericsson (Nasdaq: ERIC).

Considering how popular the company has become with our own CAPS investors, let's take a look at whether or not DragonWave is a buy, a sell, or a hold.

Buy:

  • Founded in 2000, DragonWave is still the new kid on the block. However, its recent results have been outstanding. Last quarter, it reported a revenue increase of 463%, and boosted its gross margins by more than 60%. Income from operations reached $14.6 million, compared to a year-ago loss of $3.1 million. This tremendous surge has come mostly from a deal that the company had struck with Clearwire (Nasdaq: CLWR) to help build out its network.
  • The company is expanding internationally and attempting to diversify its customer base. It has shipped to 139 different customers in the previous fiscal year, and has presence in 59 different countries from Macedonia to the Philippines.
  • DragonWave looks pretty attractive from a valuation standpoint. Its P/E multiple is a paltry 4.5, and it's expected to grow by more than 17% for the next half-decade. In addition, with $3.35 in net cash per share, there doesn't seem to be too much downside from a value perspective.

Sell:

  • The most glaring reason to sell DragonWave is its extraordinary dependence on one key customer:¬†Clearwire. Last quarter, Clearwire accounted for 80% of revenue; next quarter, that figure is expected to drop to 25% -- far below analyst expectations. Although there were rumblings earlier in the year that DragonWave might team up with either AT&T or Verizon, this now looks unlikely. Unless DragonWave can bag another whale, it's going to be in big trouble.
  • Although DragonWave helped build Sprint's (NYSE: S) new 4G network, it's based on WiMAX technology, rather than Long Term Evoluation (LTE), which is widely believed to be the new standard moving forward. Big-time cell phone carriers have a lot riding on which backhaul provider to choose -- they need them to be around for a long time to service, maintain, and upgrade products. DragonWave's inexperience and staying power are dubious at best.
  • Simply put, there's intense competition in the space. Many of the big players I mentioned above have more knowledge of LTE and greater financial firepower than DragonWave. Alvarion (Nasdaq: ALVR) recently announced that it would be supporting the upcoming TD-LTE standard in its leading 4Motion Solution. DragonWave will need to act quickly and flexibly if it hopes to keep up with changes in technology. ¬†

Hold:

  • This is still a relatively new company with a lot of growth potential ahead of it. If you've got the stomach for it, then there is little reason to sell this stock prematurely when it's just recently begun to actually make money. At such a low price, and trading 55% lower than where it was at the beginning of 2010, no one would blame you for sitting tight to see what the future holds.

The Foolish bottom line
If there's one thing that makes me nervous about any small and upcoming company, it's when they depend almost entirely on one customer. Unfortunately for DragonWave, it has a history of generating losses, and one year with one major customer just doesn't cut it for me. There are too many question marks regarding revenue concentration, the ability to create long-lasting relationships, and whether management has the aptitude to adjust out of WiMAX and into LTE. If I'm going to make a risky bet, I'd look elsewhere. But if you've already made a purchase, I'd hold on and wait for the next earnings report -- hopefully it's a good one!