ADC Telecommunications (ADCT)

Company Profile & Strategy

Based in Minnesota, ADC Telecommunications, Inc. (ADCT) is a global supplier of broadband access equipment, copper and fiber connectivity products, telecom software, and systems integration services. ADCT branded itself "The Broadband Company" and most of its products are designed to help telephony customers, wireless carriers, cable operators, and Internet service providers upgrade to higher bandwidth capacity. ADCT reports in three segments as follows: Global Connectivity Solutions (75% of third quarter of fiscal 2008 revenues) which include fiber connectivity, copper connectivity, and enterprise connectivity products Network Solutions (11%) incorporating wireless and wireline solutions and Professional Services (14%) which offer Operations Support Systems (OSS) software and systems integration services. The company has a large sales force, an extensive distribution network, and a global presence, all of which distinguish it from smaller rivals.

Investment Thesis

Innovative Strategy: The protracted 2001-2003 telecom industry downturn forced ADCT to slash operating expenses and endure necessary restructuring initiatives to focus on targeted growth segments and new markets. We are encouraged with the progress made in this regard and by the strength of ADCT's core connectivity product offerings, which have posted sustained revenue growth over the past year. Ongoing structural transformation initiatives including improvements in product portfolio management, modular designs, integrated supply chain management, and enhanced customer interactions, are expected to result in $30 million of cost savings over the current year and another $25 million of cost savings for each of the following two years. Shifting of manufacturing facilities to the low cost regions of China, Czech Republic, and Mexico is intended to add cost control and operational efficiency to its business. Management has stated further plans to divest its EMEA Professional services unit and to discontinue certain unprofitable wireless products within its Network Solutions business.

Fiber Deployment Market Opportunity: The emerging Fiber-to-the-Premise (FTTP) market continues to remain the leading catalyst for long-term growth. ADCT was awarded a significant portion of Verizon's FTTP deployment, which has connected nearly 9 million homes using fiber. Apart from winning a share of this initiative, ADCT consummated similar arrangements with other well established carriers. AT&T and Deutsche Telekom, the largest FTTX network in the European region, have decided to purchase infrastructure solutions from ADCT. In addition, numerous large carriers, from 17 different countries in Europe and Asia-Pacific, continue initiatives to deploy massive FTTP networks and accelerate Internet video solutions, requiring transport upgrades. The broadband initiatives are expected to propel sales for the company's splitter, terminal, cable, and fiber adapter products.

New Growth Drivers: Cable TV companies have emerged as a major growth driver for ADCT. These companies have started improving their broadband network transport architecture in order to compete with the telecom service providers in the digital video markets. ADCT's innovative broadcast and entertainment solutions for HDTV (high-definition TV), mobile HDTV, HD fiber, and IPTV infrastructure are helping both cable TV and telecom service providers deploy digital video and audio services. In addition, the wireless coverage capacity solutions market, another growth area for ADCT, is likely to increase to $2.9 billion in 2010 with a CAGR of 23% from 2007 levels. ADCT's wireless solutions enable mobile operators to install multiple 2G and 3G protocols with ameliorating flexibility.

Emerging Market Opportunity: Emerging markets of China and India may generate significant revenue for ADCT in future reporting periods. China is undergoing massive telecom sector restructuring that has formed three major wireless service providers, China Mobile, China Unicom-China Netcom, and China Telecom. These carriers, together, are likely to invest more than $50 billion for 3G network deployments over the next several years. India is also on verge of deploying 3G services. ADCT has solid positions in these markets as evident with increasing sales in Asia-Pacific regions, up 52% year-over-year in the reported quarter. Additionally, many mobile carriers in the Central & Latin American regions are also implementing 3G networks.

Recent Acquisitions: ADCT has taken major acquisition initiatives that are improving the company's financials. ADCT acquired LGC Wireless, a leading wireless coverage and capacity solutions provider for carriers and enterprises. This acquisition significantly enhanced the company's all-IP radio access network (IP-RAN) solutions that enable wireless operators to meet the growing coverage and capacity demand for advanced wireless services in a cost effective manner. ADCT also acquired Century Man Communication, a leading provider of communication distribution solutions in China. This acquisition expands ADCT's product offering, accelerates the company's growth potential while adding additional low-cost manufacturing facilities in China. These two strategic events are expected to infuse revenue and earnings improvements on a sequential reporting basis.

Attractive Current Valuation: ADCT is currently trading at its historical low multiples. At 9.2x forward P/E and 0.6X at forward P/S the company has a market value that is considerably below the S&P 500 and industry averages. According to our assessment, the telecom fiber equipment market has encouraging growth prospects. We believe industry dynamics, in synergy with lingering demand for higher bandwidth to support high-speed network traffic, will create new opportunities for the company's products. ADCT's balance sheet also remains firm, as management indicated the company's current cash position will be sufficient to meet its business plan execution.

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