High Hopes for Ubiquiti Networks Not So Ubiquitous

The world's top value investors love it when their best stocks ideas are selling at bargain-basement prices. For those rarified investors, companies offering fire-sale prices become no-brainer buys. So regular investors like you and me would do well to emulate the masters and look at companies offering a buy-one-get-one sale on their stocks.

Wireless communications specialist Ubiquiti Networks (Nasdaq: UBNT) went public with high hopes that the prevalence of mobile computing and communications technology would promise large growth opportunities. Unfortunately, it ran into a brick wall of counterfeit equipment that's eroding its base and generating a deluge of class-action lawsuits. While you'll naturally want to do more due diligence before buying in, this still might be an opportunity to pick up a quality stock at a severe discount.

Ubiquiti Networks snapshot

Source: FinViz.com. *Ubiquiti went public on Oct. 14, 2011. N/A = not applicable; Ubiquiti doesn't pay a dividend.

Let's just make sure there's nothing more seriously wrong with it before you go and plug it into your portfolio.

A dirty word
Counterfeit products are problem for every industry. The fashion industry seems particularly prone to the ethically challenged. Handbag maker Coach (NYSE: COH) recently won a $44 million judgment against two websites selling fake Coach goods, while Burberry won $100 million against a network of Chinese counterfeiters, as well as against retailers like TJX for selling them.

Of course, counterfeiting happens with equipment makers, too. Ubiquiti's rival Cisco (Nasdaq: CSCO) had a large counterfeit operation halted after it was found Cisco labels were being slapped on cheap Chinese imports.

For Ubiquiti's wireless networking gear, it might not be so apparent to customers that what they're buying isn't the real thing. Its former distributor, Kozumi USA, was accused earlier this year of stealing source codes and proprietary designs for its popular and profitable AirMax line of products to sell in emerging markets. Although it moved to sue the company for the infringement, it seems the level of counterfeiting was beyond what even the company suspected, as it saw fourth quarter revenues fall $3 million sequentially to $59 million, or down 5% from third quarter results.

The problem is so large that revenue could fall as much as 35% next quarter. That news sent Ubiquiti's shares plummeting more than 40%, as the counterfeiting was widespread, hitting every region hard but for North America. That's key because three-quarters of Ubiquiti's revenues are derived from international sources, and the faked AirMax products are half the total.

Analysts had hoped Ubiquiti's strong response to the counterfeiting issue last quarter would have showed tangible results, but with management offering up the reduced guidance, it seems the issue is deeper and more far-ranging than previously believed. No doubt it will be shored up, but Ubiquiti's results will be hampered for some time.

While it had been enjoying expanding growth prior to the problem, this could give rivals like Cisco, Alvarion, or Motorola Solutions (NYSE: MSI) a chance to steal share from the equipment maker. A setback like that might also make customers in its backhaul market also think twice just as its trying to break in on territory owned by Ceragon Networks (Nasdaq: CRNT) and DragonWave.

Ubiquiti ran into issues last year when one of its distributors was caught selling equipment to Iran in violation of U.S. laws. Now one of its distributors is stealing its codes and designs. Since it relies almost exclusively on distributors for its sales, management needs more controls in place to prevent a recurrence of debilitating problems.

As this continues to unfold, and until Ubiquiti gains control of the counterfeit products, it's hard to recommend its shares at the moment. I'm not quite so fatalistic as Wall Street is, though, but I think it will take another quarter or two before we see a turnaround. Let me know in the comments section below when you think Ubiquiti Networks will turn into the real deal.

Have half a mind
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