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TWST: Is ADC Telecommunications (Nasdaq:ADCT) a comparable top pick?

Mr. Notter: We like ADC Telecommunications; it’s a stock that has performed very well over the last couple of years. It has been under some pressure of late as investors have become more concerned about CLEC spending problems. ADC is a provider of broadband productivity products for carriers. They sell these connectivity products into a multitude of carriers, including ILECs, inter-exchange carriers, CLECs, wireless service providers and cable operators. In addition, they also sell to international carriers. ADC has a significant number of customers and a large array of products within their broadband connectivity product portfolio. Their broadband connectivity products are basically used to provide interconnection of circuits and equipment within a central office. ADC has other businesses that are also more systems-oriented, such as their Cellworx next generation add/drop multiplexer, and Soneplex, which is their T1 HDSL service provisioning platform. They also have products such as Homeworx Telephony, which is the solution for providing voice and data services over a cable environment. They have a large number of products, but we’ve really been focused on their broadband connectivity product area. As I mentioned, that’s a big part of the business and, by our estimates, represents almost 80% of the company’s net income stream on a quarterly basis. We like ADC because they do have a small percentage of their business coming from CLECs — about 8% from CLECs on a direct basis right now. They also have some element of the business that is sold into the CLECs through indirect distribution channels. By and large, we think their real exposure to CLECs is probably 10%-12% of revenue. That said, the ILEC inter-exchange carriers and other carriers are experiencing tremendous demand, as are the CLECs, for new telecom services. ADC has a terrific plan given that the demand for these services generates corresponding demand for ADC’s broadband connectivity equipment in central offices and other parts of the carrier network. ADC Telecommunications trades at a relatively modest valuation, right now at about 29 times next year’s earnings estimate. In addition, ADC Telecommunications has some hidden assets on the balance sheet. One is a large portfolio of public and private investments that they’ve made over the last several years. We think that portfolio is probably worth about $1.5 billion. We pull that out of the company’s market cap when we do valuation work — making the stock even more attractive. Also, the company is fairly low-risk operationally. They have a large number of customers, but only 4% or 5% of the revenue comes from their largest customer. It’s not incurring customer concentration risks — a risk that is fairly prevalent within many of the telecom equipment companies that are out there today, particularly new companies that have come public in the last few years. At the same time, ADC Telecommunications has a huge array of products. It’s not a company where you have lots of product cycle risk for individual products. Therefore, we look at ADC as a low-risk investment, and the fundamentals of the business are very strong. We think it’s a great name.