Terabeam Partnership Puts Sorrento Network's on Wall Street's Radar Screen

by Chris Connor

The Announcement

On May 22, Sorrento Networks {FIBR} took a very important step in its history when the company announced that it would partner with Terabeam to substantially expand the bandwidth capacity of Terabeam's free-space backbone network (via Sorrento's GigaMux DWDM system).  Terabeam combines the bandwidth capabilities of light and the transport dynamics of air (i.e. avoid digging up streets to lay fiber optic cable) to form an extremely powerful broadband solution with its Fiberless Optics technology.  Investors have been itching to own a piece of Terabeam ever since technology guru George Gilder mentioned it his self-named Technology Report over a year ago.  The company is still private, but now investors have a chance to own one of its partners with Sorrento Networks.  Furthermore, this partnership with Terabeam will likely have a greater effect on Sorrento's operating results than it would a larger company like Lucent {LU}. Wall Street showed its glowing approval of the partnership by bidding up FIBR 36 percent from the previous day's close. 

Misleading Revenue Numbers

At first glance, it appears that Sorrento's revenues are in bad shape; however, a closer look shows that Sorrento's revenues (taking out the lagging sales of its Meret Optical subsidiary)  are clicking right along after having shed NetSilicon and Entrada Networks from its operating results.  The confusion over Sorrento's revenues stems from the fact that both NetSilicon and Entrada Networks were spun-off and Sorrento no longer reports their results.  That said, Sorrento (the subsidiary) has reported revenues of $3.6 million, $7.1 million, and $11.1 million over the last three quarters respectively.  Moreover, the company recently announced that its Sorrento subsidiary had reported revenues for its latest quarter of $13.1 million.  Although that revenue number is down from an expected $16 million, it results in average sequential growth for the Sorrento subsidiary of about 57 percent per quarter during the past three quarters.  In other words, the Sorrento subsidiary of FIBR is the far and away the crown jewel of the company.  

All Blue Skies From Here?

Not Quite.  Although the company's flagship subsidiary is generating rapid revenue growth and the Terabeam partnership demonstrates that Sorrento is becoming a force to be reckoned with in the DWDM metro market, the crown jewel of the company is still bleeding cash and is a long way from profitability.  Excluding deferred and other stock compensation, the Sorrento subsidiary lost $32.3 million on only $26.5 million in revenues for fiscal 2001.  No matter how great Sorrento's technology is, the company cannot keep losing more money than it generates in sales without eventually going out of business.  Even the most bullish and vocal FIBR shareholders cannot possibly deny that! 

As far as cash is concerned, the company burned through $4.36 per share in cash for its fiscal 2001 from normal operations.  Even though Entrada Networks did contribute to that negative cash flow for part of the year, the major culprit here is the rapidly growing Sorrento subsidiary.  Surprisingly, the lagging Merit Optical subsidiary actually has reported positive operating cash flow, so nearly the full blame for the high cash burn rate must fall on the Sorrento subsidiary.  In addition, it is taking longer for the company to collect its accounts receivables.  From Q2 FY01 to its Q1 FY02, the time it takes for the company to collect on money owed to them from customers has increased from 86 days all the way to 125 days.  Though the company reports no payment problems, the dramatically slowing receivable turnover should be watched carefully by any potential FIBR investor, because it could lead to serious problems going forward.  

With these glaring inefficiencies, it is no wonder that stock has not been able to outperform the Nasdaq in five years (see chart below).  Yes, the Terabeam announcement is a major positive for the company going forward, but the company needs to drastically improve its financials if it wants to be a true major player in the fiber optics industry.  On that note, Sorrento's management announced in a conference call today that it has made impressive progress in cutting costs for its latest quarter.  In fact, FIBR substantially decreased its operating losses because of the combination of cost cutting and continued rapid revenue growth on a sequential basis.