Analyst Take: Meru's Opportunity in Cisco's Wireless Space (MERU, CSCO, MOT, HPQ, ARUN)

Meru Networks, Inc. (NASDAQ: MERU) saw its quiet period end this week after its recent IPO.  Meru was supposed to be one of the hot-IPOs of this year as it is thought to go in wireless networks where Cisco Systems Inc. (NASDAQ: CSCO) is.  Its pricing was at $15.00, the high-end of an adjusted $13 to $15 expected price range for a mere 4.38 million shares.  After getting as high as $20.05 after the open of the IPO, shares recently slid to as low as $3.52 on all the market scare.  We have seen recovery over the last two days as the broker-coverage quiet period ended.  BofA Merrill Lynch was the sole book-running manager, and the firm began coverage with a BUY rating and $20.00 price objective.  Then came earnings.  We are comparing the earnings and then showing the big analyst calls in its debut.

EARNINGS SYNOPSIS: First quarter revenues were up 28% to $19.6 million, as products and services revenues rose 62% to $15.9 million.  While it had a net loss on a GAAP basis after IPO-related fees, Meru reported a first quarter non-GAAP net loss of $97,000 or $0.20 per share.

Its CEO noted, “We believe Meru’s unique technology and value proposition, coupled with our expanding market presence enables us to continue executing on our disciplined and systematic plan to enable enterprise organizations to upgrade their legacy microcell wireless architectures with Meru’s next generation solutions.”

Co-managers were Robert W. Baird, Cowen & Co., JMP Securities and ThinkEquity LLC.  The coverage we have seen is as follows:

• BofA Merrill Lynch BUY $20 target;
• Robert W. Baird started as Neutral and $16 target;
• Cowen & Co. started as Outperform;
• JMP Securities and ThinkEquity ratings not seen

In the wireless network space, Meru competes against and has overlaps with Cisco Systems Inc. (NASDAQ: CSCO), Motorola Inc. (NYSE: MOT), Hewlett-Packard Co. (NYSE: HPQ), and Auba Networks, Inc. (NASDAQ: ARUN).  Its channel partners in 2009 for sales were 11% direct, 21% from Westcon, 14% from Catalyst Telecom, and less than 10% from each Avaya and Foundry/Brocade.

Bank of America/Merrill Lynch was the lead underwriter for the offering, so as the firm likely to have the largest holdings on behalf of clients we decided to focus on its opinion more than others.  BofA called it a leading contender in an attractive market… in the rapidly growing enterprise wireless LAN market.  The firm noted that Meru has a differentiated technology and is “positioned at the heart of key industry transitions.” The firm expects Meru to grow faster than the underlying market, hence why it has expectations of 35% revenue growth in 2010 and 28% in revenue growth for 2011.  For the same period, operating margin is expected to go from roughly 60% to 64% in 2010 and 66% in 2011, and EPS growth of 305% in 2010 and 148% in 2011.

The firm called Meru having technological differentiation with a unique approach to wireless LAN, broadly dubbed “virtual WLAN”. Most systems require the deployment of new access points, but Meru’s technology enables adding new capacity on existing networks without any frequency re-planning of existing access points.  More importantly stated, “Meru only captures 3% market share, but its technical advantages drive a 5% share in the new 802.11n standard.”

Some other inside bits from BofA are:
Meru serves more than 3,000 customers in 36 countries.  Installing Meru’s solution can equate to 30% capex savings versus competitor solutions…. Meru’s system also eliminates the need for site surveys, typically required by legacy systems, costing $200 to $450k… users can increase scalability by adding more access points to the network or by stacking multiple channels…. The shift to 802.11n is significant for the enterprise because it delivers network speeds up to three times the 100Mbs typically delivered over wired LAN connection…. about 90% of its wins come from displacements of existing Cisco deployments.

Two risks noted were that Meru’s size could limit its exposure to deals and drive customers to larger and better capitalized vendors; and that a small proportion of the customer will naturally gravitate with larger customers.  Still, BofA called Meru as having a first mover advantage.  One risk 24/7 Wall St. would definitely want investors to know is that this stock needs a secondary offering, even if from holders, and sooner rather than later.  While a secondary is dilutive to holders and increases the free float of shares, there is a risk in the size of the free float being this small.  Small float shares can move wildly on news in either direction, often just because of some small share orders.

Lastly, BofA notes, “Meru is well positioned in education, hospitality and healthcare, three verticals that represent roughly 45% of total revenue. There is room for deeper vertical presence and vertical expansion. As wireless networking is taking a prominent role in the broader market, we see opportunities in retail, manufacturing and government, which collectively account for about 20% of revenues currently.”  BofA’s $20 target is based upon 3.6-times 2011E EV/Sales multiple and it noted an attractive valuation after the recent share pullback represents a good buying opportunity.

Shares traded as high as $17.00 this morning, but shares closed up 5.1% at $16.30 on just over 100,000 shares.

Chart above from stockcharts.com

JON C. OGG