Two years ago, Eli Fruchter, President and CEO of EZchip Technologies Ltd. said that it was not inconceivable that the company would record revenue of $75 million in 2008. He was still optimistic when he talked to "Globes" last week although this time round he refuses to give figures. "The market we're targeting will reach $250 million in 2008-2009. I expect that we will have a sizeable chunk of it," he predicts.
Yokneam-based EZchip, which is controlled by LanOptics Ltd. (Nasdaq: LNOP; TASE:LNOP), is a fabless company that develops high-speed network processors. EZchip's chip sits in the router, and Fruchter describes it as the "Pentium of routers."
Most of EZchip's customers presently use its first generation NP-1c processor. The company began shipping the newer NP-2 to customers at the end of 2006. At the same time, it is also developing the next generations of processor, the NP-3 and NP-4.
EZchip's potential customers are telecommunications equipment manufacturers and the three largest companies in this sector are Cisco Systems Inc. (Nasdaq: CSCO), which controls 50% of the market, Juniper Networks (Nasdaq: JNPR), and Alcatel-Lucent (NYSE: ALU). EZchip has more than 100 design wins, and two of the three companies just mentioned are its customers. Fruchter refuses to say who they are but describes them as the "crème-de-la-crème in the field."
One individual who has been forthcoming about this is tech stocks guru George Gilder, who has been following EZchip for several years. In his latest report, Gilder writes that EZchip's revenue is likely to increase thanks to the sales of NP-2 processors, followed by sales of the next generation of processors, NP-3, to Cisco and Juniper from the beginning of next year. He believes that revenue of $100 million or more for EZchip in 2009 is definitely possible. For the sake of comparison, the company ended 2006 with sales of $8.5 million.
"We began shipping NP-2 processors in the third quarter of 2006," says Fruchter. "Every router has many cards and every card has our chips. The previous generation of processors had one chip in each chassis, while the new generation can take up to 64 chips. The difference in price is such that the NP-2 costs about half of the NP-1, so even if you don't fill the chassis with our chips, the potential revenue from NP-2 is ten times that of NP-1."
Since the time from the announcement of a contract win to the launch of a completed product on the market can sometimes be two to three years, EZchip is now recognizing revenue from previous years. This fact should on the face of it give the company good visibility and the ability to publish forecasts, but it doesn't do this. "We have visibility for one quarter and that's not enough," says Fruchter. "The customers' products need to prove themselves on the market. In order to increase our visibility, we need more large customers that have reached the production stage." In any event, he adds the company should not be judged on a quarterly basis. "If anyone is expecting stable growth, it won't necessarily happen. There could be surges from one quarter to the next. At the annual level, 2007 should be a lot stronger than 2006."
Globes: And when will the profit come? You lost $12.3 million in 2006.
Fruchter: "We are spending just over $1 million a month, $12-13 million a year, and with an expenditure level like this and a profit margin of around 60%, a quarter in which we recorded $5.5 million in revenue would be a profitable one. I can't say exactly when this will happen, but it will."
As a start-up, EZchip was not required to publish its results, but it is controlled by LanOptics, which is a public company. LanOptics has a market cap of $211 million, reflecting a value for EZchip of $270 million, in which it has a 78% stake. EZchip is LanOptics' sole activity, and LanOptics recently decided to raise its stake in EZchip to outright ownership. Last December it increased its holding from 60% to 78% after it gave EZchip's minority shareholders its own shares in exchange for their holdings.
"The current structure does not give us any advantage," says Fruchter, who also serves as LanOptics chairman. "It started when EZchip needed a lot of money, and LanOptics didn't have enough. We raised a total of $60 million through venture capital funds, the last part of which was raised in 2005. The goal is to simplify the structure and return to full ownership by LanOptics. The problem here is not efficiency but simplicity - people like simple things."
Fruchter notes that today two funds remain investors in EZchip - Goldman Sachs and JK&B Capital. "They hold preference shares in EZchip, and if they convert them they will receive ordinary LanOptics shares," explains Fruchter. "I assume that once LanOptics's stock is at a certain price level, it'll be worthwhile for them to convert. I believe it is worthwhile for them now. There's a good chance that it will happen as early as next year." Once it does, Fruchter believes that LanOptics will change its name to EZchip and continue trading under its new name.
EZchip is already acting more and more like a public company. The company plans to hold a conference call following the publication of its financials for the first quarter, and a road show, and it also intends to work with an investor-relations company. "The main reason for this is that a lot of investors are interested in us, largely thanks to the "Gilder Reports," says Fruchter. The company currently does not have any coverage by investment houses.
Does EZchip's market cap give a fair reflection of the state of the company and the market?
"I'm not an analyst and I don't engage in calculations of profit multiples. It has transpired from conversations with investors that the fairly high value is derived from their view of EZchip as a growth company. This is typical of many companies at the early growth stages."
EZchip recently announced a collaboration with Marvell Technology Group (Nasdaq: MRVL), an announcement that sent LanOptics' stock up sharply, even though the collaboration was known before the official announcement was made. The two companies are collaborating on R&D, marketing, and sales of network processors to the Ethernet market. "The goal is to increase exposure to Tier 1 customers, a sector in which Marvell has a very strong grip," says Fruchter. "Marvell is active primarily in the enterprise solutions sector, and our chip is designed for service providers. The combination enables us to approach customers of both companies."
Do you mean customers that are apprehensive about working with a small company like EZchip?
"That's one good example."
The collaboration with Marvell was a form of response to Broadcom Corp. (Nasdaq: BRCM), which entered EZchip's market after it acquired the privately-held Sandburst Corporation at the beginning of 2006. "Broadcom is our main competitor," says Fruchter. "Broadcom and Marvell are acting in a similar fashion to each other. They both came from the enterprise field and are trying to reach service providers, Broadcom by way of an acquisition, and Marvell through a collaboration."
Did Broadcom approach you or make an acquisition offer to you too before it acquired Sandburst?
"I'd rather not comment on that."
But do you feel that EZchip could still be an acquisition target?
"Yes, of course it could. Looking ahead, the most reasonable scenario is that LanOptics will buy the remaining holdings and reach 100% ownership, and that EZchip will continue to grow as a public company. Another option is that EZchip will be acquired, before or following a full merger with LanOptics. A third option, albeit highly unlikely, is that EZchip itself will make an offering, but there is no need for this at present."
Aside from Broadcom, EZchip faces another kind of competition, since there are companies that prefer to develop their chips in-house. One competitor now quitting the market is Intel Corporation (Nasdaq: INTC). "Intel announced that it would no longer be making any developments in the field," says Fruchter. "They're in the process of exiting the market. They developed low-speed processors, while we have been developing high-speed processors. I imaging that had they stayed in the market, they would have developed high-speed ones too." Fruchter believes that Intel decided that a market worth hundreds of millions of dollars in which other companies were also active, was not suited to a company of its size.
Fruchter notes the many changes that are now taking place in the market. "The standards are changing. The whole idea of processors is to replace chips, which are not flexible. This allows for changes to be made and the product's life to be extended when the market changes," he says. "The move to processors is a move to another technology and it takes time."
According to Fruchter, the market was worth less than $20 million in 2006, but it has grown. "Service providers have seen some dry periods," he says. "They didn't invest in new infrastructures and routers, things are now changing. There has also been a move to Internet services, which necessitates the replacement of old infrastructures, something that helps to push the processors."
Are there any other directions that EZchip could develop in?
"We began with large and expensive chips, and working our way down from that is easy. We're looking at further options, such as for example, entering the developing wireless market."
Fruchter says EZchip could also acquire companies for the purpose of growth, although the company wishes first to complete the move with LanOptics.
How will EZchip look in a few years from now?
"I don't want to commit myself as to figures, but the company will sell at levels that are a lot higher than those today. We'll take our technology to additional markets as well."
Published by Globes [online], Israel business news - www.globes.co.il - on April 30, 2007
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