Cisco’s 6,000 Job Cuts Drown Out EZchip Profits: Israel Markets

EZchip Semiconductor Ltd. (EZCH) reported double-digit earnings and sales growth last week, beating analysts’ estimates for a second straight quarter.

Stock investors barely seemed to notice.

Instead, they focused on what the chipmaker’s biggest customer, Cisco Systems Inc., said about nine hours later: it was cutting 6,000 jobs and forecast little to no sales growth amid a continuing slump in developing economies. Yokneam, Israel-based EZchip plunged 4.3 percent in New York trading the next day, the worst rout since February. Israel-traded shares gained 0.5 percent this week as of 11:59 a.m. in Tel Aviv, after losing 3.1 percent on Aug. 14.

For EZchip shareholders, the selloff is more of the same story that’s unfolded over the past 2 1/2 years, a period in which the stock sank 47 percent from a record high of $45.27. One of the big concerns last year was that Cisco and Juniper Networks Inc. (JNPR) would reduce their reliance on EZchip by making their own processors in-house. Now, it’s the slowdown in networking equipment sales at Cisco and Juniper that’s unnerving EZchip investors even as the company keeps posting record sales.

“Cisco’s outlook is taking a toll” on EZchip, Yousef Abbasi, a market strategist at JonesTrading Institutional Services LLC in New York, said by e-mail. “EZchip has a better growth trajectory, but if its largest clients are warning about slower growth, then it will see slower growth as well.”

Cisco, which made up 39 percent of EZchip’s revenue in the second quarter, said Aug. 13 that its sales fell 3 percent to $47.1 billion in the fiscal year ended July 26. Juniper Networks, which made up just 6 percent of EZchip’s second-quarter sales, forecast revenue and profit that trailed analyst estimates for the third quarter.

‘Continued Strength’

While Cisco’s annual revenue fell for the first time in five years, sales of its ASR 9000 high-end router, which is powered by EZchip processors, showed “continued strength” in the most recent quarter, Chief Executive Officer John Chambers said on the conference call with investors.

“Cisco’s sales of their ASR 9000, which includes EZchip’s network processing unit, are growing at double-digit rates and that is what matters to us with regards to Cisco,” CEO Eli Fruchter wrote in an e-mailed response to questions Aug. 15.

More analysts agree with Fruchter than with investors. Five out of nine recommend buying the shares, with an average price target of $29.95, according to data compiled by Bloomberg. EZchip’s shares are down 2 percent this year, and closed little changed at $24.11 in New York on Aug. 15.

Second Half

“We think Cisco is going to be the entire strength of the second half for EZchip,” Jeffrey Schreiner, an analyst at Feltl & Co, said by phone from Menlo Park, California Aug. 14. “There’s a lot more upside to this business and it should be valued at much higher multiples.”

EZchip’s revenue rose more than 30 percent in each of the past four quarters, and is forecast to grow 29 percent this year to $91.2 million, according to the average of six analyst estimates.

The company reported earnings of 36 cents per share in the second quarter, beating the 34-cent average analyst estimate. The shares rallied 1.5 percent on Aug. 13, before Cisco reported earnings.

EZchip trades at 16 times 12-month estimated earnings, compared with an average of 21 times over the past five years.

While Cisco’s demand for chips used in its high-end routers remains strong, broader weakness could cause “lumpiness” in EZchip’s orders from major customers, Jay Srivatsa, an analyst at Chardan Capital Markets, wrote in an Aug. 14 note. Consolidation among Cisco’s U.S. telecommunications clients could also hurt EZchip’s performance in the second half of this year, he wrote.

“We believe EZchip may feel the decline in order activity during the third quarter, which could negatively impact its fourth-quarter guidance,” Srivatsa, who still has a buy rating on the stock, wrote in the note.

To contact the reporter on this story: Gabrielle Coppola in New York at gcoppola@bloomberg.net

To contact the editors responsible for this story: Nikolaj Gammeltoft at ngammeltoft@bloomberg.net; Marie-France Han at mhan30@bloomberg.net; Richard Richtmyer at rrichtmyer@bloomberg.net Samuel Potter

Press spacebar to pause and continue. Press esc to stop.

Bloomberg reserves the right to remove comments but is under no obligation to do so, or to explain individual moderation decisions.

Please enable JavaScript to view the comments powered by Disqus.