Allot Communications and Deep Packet Inspection

The proliferation of data on broadband networks from the emergence of social media, P2P and VoIP puts a tremendous strain on telecom infrastructure. Throw into the mix cloud applications being served up by companies like Salesforce.com (CRM) and AthenaHealth (ATHN), you come to understand we are in an era of massive mobile and broadband transformation. Add the embryonic Chinese market into the picture, and the pie gets even larger. In fact, China has 988 million mobile users, many who will be upgrading to smartphones and tablets as their standard of living grows.

An average smartphone user generates multiple times the data traffic as the owner of a plain vanilla cell phone. Because of this, there will be an enormous opportunity for telecom software and gear providers like Allot Communications (ALLT) which specialize in Deep Packet Inspection (DPI). To paraphrase their annual report, "Deep Packet Inspection is basically an intelligent bandwidth management solution that transforms broadband pipes into smart networks. Traditional network infrastructure devices, such as routers and switches, do not have sufficient computing resources or the required algorithms to distinguish between different rapidly evolving applications. DPI works in tandem with already installed equipment.".

A recent Investor's Business Daily article sheds more light on the subject: "Allot relies on its proprietary DART system — Dynamic Actionable Recognition Technology...DART is a traffic-inspection system. It sorts the innocent from the malevolent and routes the traffic to the right destination in the most-efficient way. DART also tracks data usage by subscriber. DART helps address the issue of data hogs, those few that soak up a disproportionate share of available bandwidth. This helps ISPs provide the service that everyone needs, perhaps by charging the hogs (mostly peer-to-peer users) for their unusually high usage.".

To highlight just how much wireless broadband is growing, we can look no further than the semi-annual Allot Communications' MobileTrends Report H2, 2011. This shows there was explosive growth in the wireless sector from July through December of last year, and foreshadows more growth to come:

• Mobile broadband traffic grew by 83% in the second half of the year with a CAGR of 234% during 2011.
• VoIP & IM traffic grew by 114%, perhaps substantiating recent reports on SMS and international voice calls decline.
• Video Streaming traffic continues to dominate mobile broadband, with a share of 42% of total bandwidth.
• Android Market traffic grew by a phenomenal 232%, almost four times faster than the Apple App Store, increasing its momentum to become a true Apple App Store rival.
• YouTube now accounts for 24% of the total broadband traffic; 14% of total YouTube traffic is high-definition.
• WhatsApp now accounts for 18% of the IM total bandwidth, a dramatic increase in popularity from only 3% in H1, 2011.
• Facebook messenger is an all-time ‘killer app’ on mobile; rising from zero to 22% of total IM traffic in just four months.

Because of the market potential in DPI, there is a firestorm brewing with Allot's competitors. Their principal rivals are Cisco (CSCO) (through the acquisitions of P-Cube and Starent Networks) and Sandvine (SNVNF.PK) in the service provider market, and Blue Coat Systems (CFO.F) (through its acquisition of Packeteer) in the enterprise market. They also compete with a number of smaller competitors such as CloudShield Technologies and Procera Networks (PKT).

You don't have to live in Silicon Valley to surmise that Cisco is the 800 pound gorilla in this space, but they are a large company. Investors in Cisco may get price appreciation (and a small dividend) by owning the equity, but my belief is that you may make more money in pure-plays like Allot. In fact, the stock has increased from $4/share in 2010 to its current valuation of $18/share. During that same time period, Cisco has lost share value by about 20%. Smaller companies are nipping at Cisco's heels and taking market share in various sub-sectors in telecom infrastructure. An example is Aruba Networks (ARUN) in Wireless Local Area Networks.

Allot is a globally positioned organization and as last reported, they derived 60% of their revenues from Europe, the Middle East and Africa; 22% from Asia and Oceana and 18% from the Americas.

There are many red flags for a small company like Allot. They have a beta of 2.29 and, if the market corrects, the stock will fall harder. In addition, they trade only about 350,000 share on an average day. Until last year, Allot hadn't been profitable in years, but that is typical with a young growth company. Just take a look at Nuance Communications (NUAN) and their decade in the red from 2001-2010. One client also accounts for 30% of sales.

The Investor's Business Daily article also cautions: "Be aware that $22 million in sales makes Allot a tiny company, as does its $454 million capitalization.". However, the company has also reported triple-digit earnings growth for five straight quarters and sales growth has also averaged 39% in that time range. Allot Communications only made $.26/share the past 12 months and with a price of $18, we get a P/E ratio of 69. Expensive, but if they continue to cook on all four burners, that ratio will come down as Allot increases their bottom line.

Investing in a moneymaking machine isn't that common if you are screening the S&P 500. For every Apple (AAPL), there are about 499 other stocks that may give you a hefty paycheck by doubling or tripling over a five year period (which is a great return), but not be considered a winning lottery ticket. To get the really incredible gains, you usually have to take your chance on young companies to put you in the winner's circle. Allot Communications could be one such company, but I wouldn't buy it at this level. The market has come too far, too fast and is need of backing and filling. You may feel differently.

Synchronoss Technologies: Beast of Burden in the Smartphone Market

If you own a smartphone or tablet computer, you're probably using the slick software of Synchronoss Technologies (SNCR). As its name implies, it synchs up your e-mail account on your smarthone with your desktop computer among other things. Synchronoss does a lot of the heavy lifting that makes your life easier.

In a recent press release, the company explains: "With Synchronoss, operators can better manage bandwidth constraints by seamlessly switching subscribers between 3G, 4G and Wi-Fi networks for the best user experience without the complexities associated with finding a secure network and login procedures.".

An Investor's Business Daily article adds to the conversation: "Its software activates wireless accounts and lets mobile phone users automatically transfer data, such as contact lists and calendar notes, to new devices. Wireless companies load mobile phones with Synchronoss software.".

Their industry leading customers include service providers such as AT&T (T), Verizon Wireless (VZ) and Vodafone (VOD), OEM/e-Tailers like Apple (AAPL), Dell (DELL), Sony (SNE) and Nokia (NOK) and, cable operators like Cablevision (CVC), Comcast (CMCSA) and Time Warner Cable (TWC). According to the most recent 10-K: "These customers utilize our platforms, technology and services to service both consumer and business customers, including over 300 of the Fortune 500 companies.".

Because of their strong relationship with Apple, I would think that when the much ballyhooed Apple TV is released, Synchronoss may be a beneficiary. However, one caveat to the stock is a disproportional dependence on the iPhone and AT&T. Granted, they have been doing business with Ma Bell since the formation of Synchronoss in 2001, and, they have a fairly big moat around them, but if they lose their contact with AT&T, the stock would get crushed.

Chairman, President and CEO Stephen Waldis addresses the problem in the February 7th, Q4 conference call: "...the diversification of our business was an important focus during 2011, and we are very pleased with the progress made. Our non-AT&T related revenue grew to nearly 50% of our total revenue for the year. That's up from 40% of our total revenue during 2010, and we expect continued focus, efforts and success on customer diversification in 2012.".

One step Synchronoss has made to combat the overexposure to AT&T is the acquisition in early February of Miyowa. The purchase of Miyowa expands their existing mobility platform by adding powerful social networking device capabilities. This enables social and mobile to come together, delivering a significant unified and easy to use social experience for their Service Providers and OEM customers.

As the press release states: "Miyowa’s customers include Tier One carrier Orange, as well as device manufacturers such as HTC, Samsung and ZTE. Additionally, the company has partnerships with the world’s best known social networks and messaging providers, including Facebook, Twitter, Windows Live (MSFT), Yahoo! (YHOO), Gtalk (GOOG) and AIM (AOL), many through privately accessible API’s. The combined technology stacks will enable Synchronoss to enhance its cloud strategy across multiple devices and operating platforms.". This gives them a big exposure to the Android operating system.

Although the company expects the acquisition to be at least neutral to its non-GAAP earnings per share for 2012, they have a history of reporting mind-numbing numbers that exceed analyst projections. Early last month, Synchronoss beat views and gave 2012 guidance above expectations. In fact, for 2011, they upped analyst numbers every quarter, and bettered the average estimate in December by a whopping 47%. This was probably primarily due to the popularity of Apple's mobile products.

Since its IPO in 2006, the company has been profitable, and, carries very little debt. It currently trades at $31/share, roughly in the middle of its 52 week range of $22 on the low, and, $39 on the high side. Current fiscal year average earnings estimates are $1.10/share, and, for 2013, $1.31/share. These same analysts project earnings growth of 12.2% for 2012, 19% for 2013, and, a 5 year compound annual growth rate of 20%. These estimates may prove to be conservative if smartphone and tablet proliferation continues to grow at a rapid pace.

With a P/E ratio of 30, the stock might have gotten ahead of itself, which could account for its range bound performance the past 12 months. Synchronoss has moved sideways since the beginning of 2011 after an incredible 7X increase from the 2009 lows. Even a recent initiation of coverage as an outperform, and, an elevated price target of $41-$44/share by Wells Fargo (WFC) didn't budge the equity.

The markets have come a long way in the past four months and are probably due for a correction. With a short float of 19%, Synchronoss can probably be bought for a reduced rate. That said, I really like this company and would like to add some to my portfolio because of its growing importance in the expanding mobile computer marketplace.

Uncle

It's been over two months since my last posting, and the markets have roared. In fact, when examining a calendar year, it's one of the best starts in decades. Since early October of 2011, the NASDAQ is up almost 30%. That's more than a nice return in a short period of time if you are long the cubes (QQQ). Because of the acceleration in stocks, in early January I liquidated my leveraged/short ETFs, which are the ProShares UltraShort S&P 500 (SDS) and the Direxion Daily Small Cap Bear 3X Shares (TZA). I'll just take the tax write-offs and move on.

However, I still don't believe we're out of the woods yet in regards to a double dip in the overall indexes. For every prognosticator of a new bull market, you get your Jim Rogers, George Soros, or Rick Santelli warning of some serious reckoning in the next year or two. A reckoning that likely will be much worse than 2008/2009. With IPOs like Yelp (YELP) gaining 65% on the first day of trading, it seems a bit like the late 1990's. I'm airing on the side of caution still, and, will remain in cash, although I have limit orders in on two securities that need to drop significantly in price before I buy them.

A few things have caught my eye in the last month. One is a statistic that: "Mobile devices will account for about 80% of all broadband Internet connections in the G-20 nations by 2016, according to Boston Consulting Group.". I enjoy my iPhone and fully understand what all the fuss is about. This is why I am going to begin writing a series of articles on primarily small, pure-play companies in the tablet and smartphone sector.

For the past 18 months, I've been blogging almost exclusively about cloud computing companies, and most of these securities have extremely elevated valuations. Sure, they will continue to grow at a rapid pace, but I wouldn't want to put my money behind them. I learned my lesson in 2000 when I sold stocks like EMC (EMC), Oracle (ORCL) and Cisco (CSCO) before the crash, only to get burned by investing in technology stocks with "decent" PEG Ratios. Everything got taken down in the aftermath of the crash, and I left some money on the table.

What I want to do with this new series, is look at the young upstarts that may be big winners as the wireless Web engulfs the globe. Many of these equities are dangerous because of their brief trading history, but what stock isn't? Just look at the recent history of "sure things" like General Electric (GE) or General Motors (GM). It's always what your risk/reward is. The type of equities I am going to cover in depth are primarily small caps or micro caps. I'll try to stay away from the pink sheets, but some of the companies I'll be looking at haven't made it to the major exchanges.