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Sweeter Notes From Harmonic

By Stephen D. Simpson, CFA
Tue Jun 7, 2:33 PM ET

At long last, I can find something positive to say about a cable equipment company. While Harmonic (Nasdaq: HLIT - News) has had its problems recently, I have always been optimistic because of the promise of the underlying business.

Today, Harmonic added a little good news to the mix. On top of announcing two equipment deals (one in Canada, one in Japan), the company said it's expanding its working relationship with Microsoft (Nasdaq: MSFT - News).

The two companies will work together to integrate the Microsoft TV IPTV Edition software with Harmonic's DiviCom encoding technology. Cutting through the technospeak that accompanied the announcement, the combination will allow customers to deliver more feature-rich digital TV content while gobbling up less bandwidth.

Although this sort of arrangement will likely be most attractive at first to telephone companies, everybody who tries to send information over wires is looking for ways to send more information without laying more wires. Nevertheless, this technology allows for TV to be transmitted over DSL lines and IP networks and could represent an avenue for telcos to compete with cable companies in the TV space. And after all, because cable TV players are getting into the digital phone service game, isn't it only fair that telcos try to respond in kind?

Nobody should expect this agreement to bring immediate change to either company. For Microsoft, it's another small step toward its corporate goal of providing software outside the obvious computer worlds. For Harmonic, it's another incremental enhancement that should ultimately expand its market and product offerings.

I'll leave it for other Fools to debate the merits of buying Microsoft today,but I am still deeply curious about the prospects for cable equipment players like Harmonic and C-COR (Nasdaq: CCBL - News). With cable, phone, and broadband companies trying to squeeze ever more data down the same pipes, I just have to believe that the market as a whole has real potential.

Harmonic has some definite challenges to face -- a big quarterly disappointment is fresh in investors' memories -- and it plays in a tough market. But if it can get things together, I think patient shareholders might like what they see.

For more on the cable TV world, see:

Sour Notes From Harmonic C-COR Unplugged Again Motorola's Ups and Downs Scientific Facts

Fool contributor Stephen Simpson has no financial interest in any stocks mentioned (that means he's neither long nor short the shares).

Sour Notes From Harmonic
http://www.fool.com/news/mft/2005/mft05042514.htm

By Stephen D. Simpson, CFA
04/25/2005


At first blush, some investors might be tempted to think that broadband-solutions provider HarmonicLightwaves(Nasdaq: HLIT) had a pretty good quarter.

After all, weren't sales up 32% to $73 million, and didn't net income of $1.7 million reverse a year-ago loss? Well, yes, but the trouble comes from those pesky Wall Street analysts. See, while the company posted income of $0.05 a share (before items), the analysts' average estimate for the quarter was $0.09.

That seven-cent miss, coupled with disappointing guidance for the next quarter, translated into a 30% decline in Harmonic's stock in trading on Friday.

The biggest problem in the first quarter was the nature of the orders that Harmonic received from its customers: The company saw an unprecedented increase in customer demand for third-party equipment.

These products carry much lower margins for Harmonic, and as a result, the company saw a gross margin decline on an annual and sequential basis. What's worse, Harmonic management sees those high levels of third-party orders continuing and pressuring margins into the next quarter.

For the quarter, Comcast(Nasdaq: CMCSA) and Charter Communications(Nasdaq: CHTR) remained major customers, and cable companies as a group made up 75% of sales. Satellite-TV providers accounted for 10% of the quarter's business, and the remainder came largely from telco providers.

Sure, it's tough to drum up excitement for a company that just posted a major disappointment that sent the stock down 30%. What's more, when you see other small cable-equipment providers like Terayon Communication Systems(Nasdaq: TERN) and C-COR(Nasdaq: CCBL)struggling, you're tempted to question the whole thesis that cable companies need to spend more to improve their services.

That said, I still like the business. Cable companies continue to roll out services like digital video, video on demand, high-definition television, and high-speed Internet and telephony services. And those services require equipment like Harmonic's headends. What's more, telco companies remain a wild card, with fiber-to-the-premises and video services both holding significant promise.

Of course, Harmonic isn't the only game in town. Rivals like Scientific-Atlanta(NYSE: SFA) and Motorola(NYSE: MOT) can offer turnkey solutions and end-to-end product suites that are certainly attractive to buyers wanting to deal with a sole supplier.

Still, the market should be big enough to allow small and specialized firms like Harmonic to both survive and thrive. Of course, for that to happen, Harmonic needs to keep investing in R&D to stay ahead of the competition, boost profitability, and sell more of its own gear. Although 2005 isn't off to a roaring start, the race isn't over just yet, and Harmonic could still produce sweet notes for investors down the line.

For more on the cable space, check out these other Foolish takes:

C-COR Unplugged Again
Motorola's Ups and Downs
Scientific Facts
Watch More TV: Do It for C-COR
Comcast Casts Wider Net

Fool contributor Stephen Simpson has no financial interest in any stocks mentioned (that means he's neither long nor short the shares).