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How Risky Is Extreme Networks, Inc.?

By Anders Bylund - Jul 9, 2017 at 8:14AM

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The network equipment company is building a much larger and more complete beast through a basket of pending acquisitions.

Shares of Extreme Networks (EXTR -3.47%) have soared 166% higher over the last 52 weeks, including a 79% gain in 2017 alone. Is the networking equipment provider's stock getting too hot to handle, or do Extreme's shares truly belong at these higher altitudes?

Let's find out.

Network cables plugged into a bank of switches.

Image source: Getty Images.

Extreme's rise

This is one of those overnight sensations that were years in the making.

Extreme has been building a complete portfolio of networking solutions by way of many small but needle-moving acquisitions. The company you see today includes networking operations that formerly were part of industry giants such as Siemens, Motorola, Nortel, and Cabletron Systems.

Right now, Extreme is looking to close a $100 million buyout of Avaya's networking division, followed by a still-pending agreement to shoulder Brocade Communications Systems' (BRCD) data center networking operations for $55 million. The Brocade buyout is part of the closing conditions for a larger deal, as semiconductor titan Broadcom (AVGO -1.15%) is picking up the rest of Brocade for a cool $5.5 billion.

When the dust settles around the Avaya and Brocade transactions, Extreme hopes to gain a total of $430 million in annual revenues from the two new assets. Both deals are also expected to deliver positive operating earnings and cash flows from day one. Piece by piece, Extreme Networks is joining a very select group of companies with a top-to-bottom portfolio of enterprise networking solutions. From Ethernet and coaxial cable to wireless and cloud computing, "The New Extreme" can do it all.

What's next?

The Brocade and Avaya deals are set to expand Extreme's annual sales by a staggering 77%. Neither one of those acquisitions has actually closed yet, so investors need to keep a close eye on that progress. There's no reason to believe that these game-changing buyouts will fail, but uncertainty is next to business risk.

And there seems to be plenty of risk baked into Extreme's share prices at the moment. Despite the massive share prices gains I noted earlier, the stock trades at just 19 times forward earnings and 23 times trailing free cash flows. Assuming that the post-merger version of Extreme should be able to reap cross-selling and cost-cutting synergies from its newfound economies of scale, well, these ratios are starting to look mighty low. Market makers don't like sources of uncertainty like unsigned buyout deals.

So I don't see a ton of valuation risk here, and the execution risk is also relatively low when you consider Extreme's long history of successful buyout deals. The company fell out of favor a few years ago, when it still focused on old-school Ethernet networking, but the acquisition strategy has already turned Extreme in a whole new direction.

There's no such thing as a risk-free investment, but having Extreme Networks in your portfolio should not make you lose sleep or send you on a fidget-spinner buying spree. It's actually a good-looking investment idea right about now.

Anders Bylund has no position in any stocks mentioned. The Motley Fool recommends Broadcom. The Motley Fool has a disclosure policy.

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Stocks Mentioned

Brocade Communications Systems, Inc. Stock Quote
Brocade Communications Systems, Inc.
BRCD
Broadcom Limited Stock Quote
Broadcom Limited
AVGO
$552.05 (-1.15%) $-6.40
Extreme Networks, Inc. Stock Quote
Extreme Networks, Inc.
EXTR
$13.92 (-3.47%) $0.50

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