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Stock Strategist

These Networking Firms Offer Growth and Value

Some of these picks should see great long-run growth--others are too cheap to ignore.

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Shares of telecom equipment and data networking firms have been on a steady slide for the better part of a year, and they've taken a severe beating along with the rest of the market. The Dow Jones U.S. Telecom Equipment Index, which consists of familiar names such as  Cisco (CSCO) and  Motorola (MOT), as well as less-familiar niche vendors like Finisar (FNSR) and  Sonus (SONS), is down about 30% since August and has been cut nearly in half over the past 12 months. Near-frozen credit markets, a down-trodden U.S. economy and the threat of a protracted global recession have prompted investors to indiscriminately sell equities, especially those that face significant uncertainty in the near term.

The outlook for the telecom equipment and networking industries over the next few quarters isn't good. Telecom equipment vendors have been dealing with weak demand since 2007, and further deterioration seems likely, given the current environment. Demand for networking gear is also likely to be put on hold at many firms, as managers wait before spending. Many telecom and networking equipment firms have also relied on Asia and emerging markets to fuel growth recently, with a weak dollar further boosting revenues and cash flows. Unfortunately, the European economy is deteriorating and previously fast-growing markets such as China, India, and Brazil are quickly losing steam. Moreover, a stronger dollar will likely turn what had been a nice boost into a significant head wind.

Turmoil in the capital markets is causing significant disruption to the business plans of firms in the telecom equipment industry. Chinese giant Huawei recently chose to delay the sale of its mobile phone business until a better selling environment materializes. This decision doesn't reflect well on the value of Motorola's wireless phone unit and could hinder its ability to spin off the business next year. Meanwhile, embattled  Nortel (NT) felt compelled to offer up its fast-growing Metro Ethernet business to raise cash and streamline its business at a very inopportune time. And, investors are skeptical that any deal can get done in this environment.  Foundry's (FDRY) stock price fell below $14 at one point, more than 20% lower than the cash portion of  Brocade's (BRCD) buyout offer, despite announcements that Brocade had secured the necessary financing and that the deal is expected to close this year. At this point, fundamentals seem to be taking a back seat to emotions.

The good news is that all of this fear and turmoil has created some compelling buying opportunities. Growth investors can find promising opportunities without paying a hefty premium, and value investors are now finding opportunities that didn't exist just months ago. Given all of the bargains, we recommend that both sets of investors screen out firms with shaky balance sheets. We believe Cisco fits the bill beautifully for most investors and that the stock is compelling currently. But, given that firm's iconic status, we dug a bit deeper to find four less well-known companies that we believe are also trading at very attractive valuations. The first two,  Juniper (JNPR) and  F5 (FFIV), are well positioned for continued long-term growth. The last two,  Radware (RDWR) and  Extreme Networks (EXTR), fall into our "too cheap too ignore" bucket, as each is trading at a market price that is near or below the net cash that the company holds on its balance sheet.

 Juniper Networks, Inc.
Moat Rating: Narrow | Fair Value Uncertainty Rating: Medium | Morningstar Rating: 5 Stars
From its start in the late 1990s, Juniper has catapulted itself into the number-two position in service-provider routing, enterprise routing, and overall network security. The convergence of network infrastructure will necessarily progress toward Internet protocol-based systems, creating an increased dependence on Juniper's IP-based network equipment. Although near-term economic weakness will likely mute demand for routers, we think Juniper's long-term growth prospects remain intact.

 F5 Networks, Inc.
Moat Rating: Narrow | Fair Value Uncertainty Rating: High | Morningstar Rating: 5 Stars
During the last several years, F5 has doubled its share of the application switch market--largely at Cisco's expense--by emphasizing a software-based approach to traffic management. F5 has incorporated more features into its switches, including security and wide-area network optimization, which in turn makes its customers more reliant on its devices and less likely to change vendors. We believe that F5 should continue to benefit from the proliferation of bandwidth-intensive applications, such as video, and we expect the company's revenue growth to average roughly 16% during the next five years.

 Radware, Ltd.
Moat Rating: None | Fair Value Uncertainty Rating: Medium | Morningstar Rating: 5 Stars
In 2006, Radware's ineffective marketing, confusing product line, and inability to attract new selling partners began to take its toll on growth, and the company's market share steadily declined from 9% to roughly 6%. Late in 2006, management began taking steps to fix the Radware's problems, reorganizing its poorly performing U.S. salesforce and making its switches simpler to manage while incorporating more functions. After two years of declining revenues within the United States, Radware is showing improvement in this geography. We believe that Radware's current net cash balance of more than $150 million, or nearly $8 per share, mitigates much of the downside risk from its current share price.

 Extreme Networks, Inc.
Moat Rating: None | Fair Value Uncertainty Rating: High | Morningstar Rating: 4 Stars
Extreme Networks has been working to fix a litany of issues over the past five years, from declining revenues and inconsistent profitability to key employee defections. Although we don't believe that Extreme can compete effectively against industry giants like Cisco and Huawei over the long haul, the company does have a decent portfolio of technology patents; key partnerships with  Siemens (SI),  Ericsson (ERIC), and Avaya; and more than $1.75 per share in cash equivalents on the balance sheet. For now, we believe these assets put a backstop on Extreme's stock price.

Grady Burkett does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.