Yesterday, Comverse Technology (NASDAQ:CMVT), a leader in multimedia telecommunications applications, turned in its first quarterly profit since mid-2002. Like other telecommunications stocks, the stock has had a wild ride. It traded above $120 per share in Jan. 2001 then fell to below $7 by late 2002. It has since stabilized in the $15-$20 range.
The company reacted quickly and effectively to the downturn in the telecommunications sector. Revenues fell 42% to $736 million in 2002, as customers such as Verizon Communications (NYSE:VZ) and Sprint PCS (NYSE:FON) cut back on spending. But revenues bounced back last year to $766 million, fourth-quarter revenues increased 15% over 2002, and its current backlog is very strong.
In addition, Comverse aggressively managed costs as revenues fell, cutting R&D and SG&A costs by over 20%. The company's balance sheet is also in great shape, with little debt and $2.2 billion in cash and short-term investments.
All signs point to a turnaround. With cash on hand for continued acquisitions, a streamlined cost structure, and an upturn in revenues, the company is poised for a solid year in 2004.
But the stock market has gotten ahead of itself on Comverse. After doubling in the last 12 months, the stock is now pricey, trading at an enterprise-value-to-revenue ratio of 2.9.
The expectations for future cash flows implied in the stock's current valuation are overly optimistic. The company's core division, which contributes 65% of sales, is in a rapidly maturing market with products such as voice messaging and call answering software. While sales at Verint (NASDAQ:VRNT), the subsidiary that makes digital security products and currently represents about 25% of sales, have soared, the rapid rate of growth seen since Sept. 11, 2001, for security software is unlikely to be sustainable over the long-term.
In addition to facing challenges to grow the top line, Comverse will see increased pressure on margins. As the recent acquisition of AT&T Wireless (NYSE:AWE) by Cingular illustrates, the wireless industry is consolidating as subscriber growth slows. Further consolidation is widely expected, and newly consolidated operators will use their increased purchasing power to drive price reductions from vendors.
While Comverse has demonstrated its operational excellence in returning to profitability so quickly after the meltdown in its industry, current valuation metrics reflect expectations that are unlikely to be met. It's a great turnaround story -- just not a great investment opportunity.
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Motley Fool Contributor Salim Haji does not own shares in any of the companies mentioned.
