Today I’m dumping shares of Sprint Corp. and using some of the proceeds to buy shares in one of the arms dealers of the wireless industry – a relatively small Ottawa-based company called DragonWave Inc.
I originally purchased shares of Sprint Nextel Corp. (as Sprint used to be known) for my Strategy Lab portfolio as a turnaround play. But now that Japan’s Softbank has acquired the majority of Sprint’s stock, I’m selling my shares and redeploying the cash to an area that I think can see much higher growth and more return on my dollar.
Some of you may remember me writing about DragonWave in March. At the time, the stock traded at $1.65; it has climbed to about $3.00 today. I wasn’t ready to buy it back then, but despite its climb, I’m now more willing to accept the risk of this small cap stock in my portfolio.
My change of heart has a lot to do with the massive amount of money being poured into building high speed 4G wireless data networks, both in emerging markets and here at home. These networks are designed to deliver much faster transmission speeds than the 3G – for third generation – systems that had been the norm.
In the United States, Sprint was in the process of launching its 4G LTE network. But on its own, it didn’t have the capital to quickly catch up to leaders Verizon and AT&T. Softbank, which just acquired Sprint, now plans to invest $16-billion (U.S.) in the Sprint network over the next two years to close that competitive gap.
When big investments like this start happening, I like to look at who benefits. Back in the late 1990s, during the telecom boom, it was fibre optic component makers like JDS Fitel. This time around, with the 4G wireless boom, I think DragonWave will be a likely winner. This small Canadian company makes wireless equipment that brings lots of bandwidth to 4G cell towers. It’s a supplier to Clearwire, a U.S. network operator that built one of the first U.S.-based 4G networks.
Several years ago, Clearwire did a $3.2-billion financing from partners, including Intel, Google, Sprint, Comcast and others. As soon as the money hit Clearwire’s bank account, the company began to execute on their plans to build out their network. DragonWave’s revenue soared, as did its stock.
That is, until Clearwire had burned through the money earmarked for network construction and had to slam on the brakes. DragonWave had not yet diversified its customer base enough to compensate, and the stock came crashing down to earth, tumbling from a peak around $14 a share.
It looks ready for another growth spurt. Sprint now owns 100 per cent of Clearwire, and Softbank, which owns the majority of Sprint, has plenty of capital to deploy. It seems obvious to me that Sprint is going to continue to roll out the same network architecture that Clearwire already started. DragonWave has a significant role in this, and Softbank’s planned $16-billion spending is much larger than Clearwire’s prior $3.2-billion funding round.
DragonWave also has better diversification today than it did during its past phase of growth. Nokia Siemens Networks (NSN) is a major player in the build-out of 4G wireless networks, and NSN previously manufactured its own microwave radios to transport bandwidth to and from a cell tower. DragonWave acquired this business, and is now a major supplier to NSN.
The networking giant Cisco also selected DragonWave’s products to be part of what it calls the “small cell wireless backhaul ecosystem”. Put another way, Cisco plans to sell DragonWave equipment to bring bandwidth to small cell sites used in dense urban locations. Cisco and DragonWave are already jointly bidding on projects.
Is an investment in DragonWave a slam dunk? Not at all. It’s quite risky. DragonWave only has $24-million of cash on its balance sheet and is burning through it, although at a slower rate than in the past. Management thinks the company is about two quarters away from achieving break-even status. Any bumps in the road could lead to big problems.
But with Sprint, Nokia Siemens Networks and Cisco all seeing value in what DragonWave offers, and a healthy pipeline of customer activity, I am willing to take the risk.
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