Extreme Networks (EXTR +0.07%) recently reported solid numbers for the first quarter of its 2018 fiscal year, showing continuing progress on the company's transformation over the past year. The company is in the process of doing a rare thing for a small-cap tech company: growing by acquisition How is the company managing it?
The networking world is being turned on its head by software-defined networking, causing many smaller players to either be acquired or go bankrupt. Extreme has been on the winning side. Over the past year, the company bought the wireless networking unit of Zebra Technologies for $51.1 million, the networking assets of bankrupt Avaya Technologies for $100 million, and data center networking assets from Brocade, which is in the process of being bought by Broadcom, for about $55 million.
Since these assets came from business unit divestitures or via bankruptcy, it seems that Extreme Networks got extreme discounts, having bought each for a less than half of the asset's annual sales. Now, Extreme has patched together a much more complete end-to-end networking platform. But can the company cobble together a bunch of random networking assets into a premiere enterprise platform?
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Organic growth
In the first quarter, Extreme grew revenue 73%, inclusive of acquisitions, and non-GAAP earnings per share improved to $0.16 per share, up from $0.07 a year ago.
CEO Ed Meyercord was very proud to announce Extreme Networks' core portfolio also grew organically. "We are especially pleased to report another consecutive quarter of organic growth primarily driven by our enterprise switching solutions and solid wireless performance that was above current industry growth rates."
That may be due to the fact that the company not only acquired new products, but also new customers, and was thus able to cross-sell its offerings to a number of them.
Margin expansion
Extreme Networks also has a goal of expanding its gross margins to 60% in short order. This quarter, gross margins declined slightly to 56.7%, down from 56.8% year ago. However, Meyercord was quick to point out that the company had acquired the lower-margin Zebra WiNG business since then. Excluding that, margins would have actually expanded to 58.5%.
In the current quarter, management guided to a non-GAAP gross margin of 56.9%-58.4%. This will be much higher than the GAAP gross margin figure, due to some initial costs associated with taking on Brocade's data center business, which the company just closed in October.
Taking on the competition
Extreme Networks stock has had an extreme run, up 160% over the past 12 months. Whereas the market viewed the company as a tiny, weak player in an industry undergoing commoditization and change a year ago, the company can now deliver full solutions, from the data center to the network edge with a full suite of products. This is a bundling strategy akin to the one employed by giants Cisco and HP Enterprise.
On that note, Meyercord said, "Enterprise customers no longer need expensive Cisco-trained engineers to write command lines to perform network functions. They can run much more efficiently and more quickly with our user interface, running Extreme Management Center over our simple, secure and intelligent networking fabrics."
As of this writing, Extreme Networks has a market capitalization of $1.35 billion, and the company hopes to achieve $1 billion in sales this year. Moreover, it's profitable, even after making three acquisitions, which is impressive. Still, rival Cisco boasts a $170 billion market capitalization and $48 billion in revenue. It remains to be seen if Extreme can really grow outside its niches in education, hospitality, and healthcare, or if it can continue to expand margins in what is still a fiercely competitive industry.
After such a big run, investors should see how the integration goes, and whether Extreme can parlay that into more organic growth. That may take a few more quarters to figure out. Nevertheless, Extreme Networks is a very interesting business worth watching.
