What the short players missed at EZchip

Shlomi Cohen

The hedge funds thought they would repeat their second quarter success with EZchip's third quarter results; they were very badly mistaken.

A classic wipe-out of short players occurred in trading in New York on Thursday, after the results and guidance from EZchip Semiconductor Ltd. (Nasdaq: EZCH; TASE:EZCH), and at its intraday high the share price was up 26%. On the eve of the results, hedge funds specializing in short positions took a big gamble against the semiconductor company from Yokne'am. There was a great deal of logic on the side of this gamble, given that the end-customers for EZchip's products, the telephone manufacturers, have frozen investments in recent months.

Just before the release of the second quarter financials, the short funds sold three million EZchip shares short, and were highly successful, because the company then published a severe warning about the third quarter. This time, they raised the stake to five million shares, almost a fifth of the company. At the average daily volume, it would take 35 sessions to cover a short position of that size, and these are precisely the situations in which short investors are duly punished if they make a mistake.

On the eve of the results, the atmosphere around the stock was funereal, and all the analysts came out with pessimistic short-term projections. Even members of the Gilder Telecosm Forum, who, as is well known, collectively hold very large quantities of the stock, and usually err on the side of excessive euphoria as the quarterly results approach, were in complete depression this time. Some of them wrote that they had sold shares, and some reported lending shares to short funds, because they are long-term investors, and, for the time being, the lesser evil is to receive interest on these borrowed shares.

No-one doubted that the company would meet the market's expectations for its third quarter results, but EZchip's management pulled a big surprise with their fourth quarter guidance, which was provided during the conference call, but which was hinted at in the results announcement.

It turns out that, at the end of the third quarter, customers who up to then were not in routine production with new systems based on EZchip's fourth generation chip (NP4) started to produce and to place orders, despite the freeze in investments.

This rollout led management to guide for sales of at least $14 million "with high confidence" for the fourth quarter, instead of the $12 million forecast by the analysts.

If you examine what happened in the telecom market late in the third quarter that might have led some of the big telephone makers to open up their wallets and order advanced equipment, you find that the iPhone 5 with LTE was launched a little earlier than the analysts expected.

Telecommunications providers like AT&T (T), Verizon (VZ), Softbank and KDDI in Japan, two of the largest providers in Korea and several large providers in Europe, all have LTE networks with partial coverage and reception capability. Since they all sell the iPhone 5, and since they were aware that there would be a rush on the this handset, they hastened to order equipment, among other things NP4-based routers.

Things get hotter at OTI

People on the capital market tend to attribute a high level of professionalism, resting on in-depth research, to hedge fund managers. In the case of EZchip, the funds fouled up big-time, because had their analysts listened, two days before EZchip's results, to the presentations at the special analysts day held by LTE market leader Ericsson (ERIC), they would have heard about this rollout, which was no everyday rollout.

Last Tuesday, Ericsson Head of Business Unit Networks Johan Wibergh said during a presentation at the analysts day that the unique routers they had developed, the SSR 8000 family of Smart Services Routers, were starting to take off. If in the summer they had only six contracts, by last week they had 22 contracts year-to-date, and he added that the strong momentum was continuing.

Unlike Cisco (CSCO), which sells two different platforms, one for fixed-line communications and one for mobile (both with the NP4 chip), Ericsson's platform serves both types of communications simultaneously, and is suitable for cloud computing applications as well. Since it is known that Ericsson's systems too are based on EZchip's NP4 network processor, it is clear why, in the fourth quarter and afterwards, Ericsson will start to be a substantial customer for EZchip, although it will always be a long way behind Cisco, which leads the network router market, and whose three platforms are currently all based on the NP4.

Finally, On Track Innovations (OTIV). At Friday's shareholders meeting a majority voted down the appointment of the three directors proposed by the management, namely Yossi Peled, Meir Nissensohn and Ora Setter. The control battle now moves on to the next stage, and at one of the coming shareholders meetings the US investor who holds 10% of the company will attempt to appoint American directors more to his liking, with the aim of replacing the management.

Published by Globes [online], Israel business news - www.globes-online.com - on November 12, 2012

© Copyright of Globes Publisher Itonut (1983) Ltd. 2012

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