Potential For Great Risk, But Also Greater Reward

On the face of it, Dialogic has been consistently growing earnings, expanding its product portfolio, and is then positioned to capture global demand for then and there-generation communications. Digging through all the fluff, we find a $90 million liability that the company won't be able to continually sweep in accordance with the rug come January. The loan that helped facilitate the Dialogic/Veraz merger had several covenant agreements based on improbable growth patterns. Dialogic has breached two of these agreements and will breach another in Q3. Explained furthermore in the Risk section, this $90 million liability could dramatically tip the risk reward scale.

For over 25 years, Dialogic has been providing communication platforms and research to enterprise and service provider markets. The merger in October positioned DLGC to take advantage of the growing demand for video streaming and bandwidth optimization within growing international markets. The company's global presence reached over 80 countries and 650 clients. Many of their products were integrated into other solutions that reached over 3000 end users.

Second quarter earnings came in at $55.8M up 25% from Q1. This represents the third quarter since the merger and the company's highest revenue in a single quarter ever. GAAP EPS anticipated for Q3 and Q4 are $.23 and $.54 respectively. Revenue guidance for 2011 is slated to come in between $220-$230 million compared to $100 million in 2010.

Breaking out Q2 geographic data, 45% of revenue came from the Americas and 55% came from Europe, Middle East, Africa, and Asia Pacific. Macro trends show considerable growth in the emerging markets, exactly the BRIC regions. Within these regions there is a lot of growth activity, especially in the telecom space. DLGC clients include 23 of the top 25 telecom networks in the world. Mobile network subscribers rates for the BRIC nations are as follows: Brazil 174M, Russia 230M, India 670M, and China 747M.

Based on industry trends and channel checks, a lack of fixed infrastructure will spur mobile data and mobile broadband in emerging markets. 3G and Long Term Evolution (LTE) will make up 43% of all mobile connections by 2014. The Telecom Regulator Authority of India (TRAI) reported that the number of Indian subscribers capable of accessing data services more than doubled in 2010 from 127 million to 274 million subscribers. This year, India has more cell sites coming online than all of the US and UK combined. Intense competition amongst telecoms for 3G is prompting some to roll out LTE services. In either case, Dialogic stands to benefit from the accelerating demand for mobile bandwidth.

The merger not only expanded the company's product portfolio and market opportunities, it as well brought cost reductions. Annual operating rates are expected to come in at $120M. The scalability of DLGC's operating structure will allow earnings to exceed $300M during maintaining current operating expenses.

Stand-alone company

As a stand-alone company, Dialogic is in position to modestly grow earnings. Nevertheless, in a space already notorious for mergers and acquisitions, at its attractive price, Dialogic is a target. Considering the company’s liquidity position, it is unlikely that it will be the one acquiring another company. Unified communication leaders Broadsoft, Acme Packet, and Adtran would gain more footholds with the acquisition of Dialogic. Not only would the company gain enterprise clients, it would broaden its international carrier exposure.

Sonus Networks and Audiocodes are two companies that would gain market share if merged with Dialogic. Sonus especially has been seeing declines in its legacy products in recent quarters and is looking to reinvent itself in the mobile space. With in broad outline $400M in cash, Sonus is likely to look outside for growth. Dialogic would be a perfect match with its media gateways and mobile backhaul.

The company's legacy TDM products include media processing boards that range from analog interface to T1 and network interface boards. These boards provide service providers and enterprises with a variety of media processing features. Features including conferencing, voice play and record, VoIP (Voice over Internet Protocol), video, and fax.

Next-Generation products contain IP and IP-enabled products. These include both call control and multimedia processing infrastructure products and platforms. ControlSwitch, a call control product, supports service providers through the IP transition process and optimization of their existing TDM networks. Multimedia processing infrastructure products include PowerMedia HMP software, BorderNet 3000 Session Border Controller, and a portfolio of media gateways. PowerMedia HMP software performs multimedia processing tasks using existing APIs and does not require any additional hardware. Tasks include voice and video conferencing, video transrating, and more. BorderNet 3000 Session Border Controller provides mobile and fixed VoIP networks a security and session management platform.

Dialogic’s media gateways interconnect different types of media to create end-to-end paths for voice, data, and video within enterprise and service provider environments. These gateways include server provider, voice, and video gateways. Server provider gateways can support IP-to-IP transcoding for network peering and optimize bandwidth. Bandwidth optimization gateways allow service providers to gain more bandwidth with their existing infrastructure. I-Gate 4000 SBO Mobile Backhaul solution can gain 50% additional bandwidth. Voice and video gateways support video and voice-only calls simultaneously. This allows for efficient integration into a carrier network’s environment.

The communication platform

The communication platform and innovation market is highly competitive and rapidly changing. The market has many players: Acme Packet, Alcatel-Lucent, Audiocodes, Cisco Systems, Genband, Huawei Technologies Co., Radisys Corporation, and Sonus Networks, among others. There are currently no market leaders. Dialogic believes the company is winning major deals due to its proprietary research, reliability and pricing.

Although the company has been seeing its legacy TDM product revenue decline, in other words due more to a change in research than it is the current economic turmoil in the US and EURO markets. The turmoil has not led to any major hiccups in the Dialogic revenue stream. The fast growth of its then and there generation products is expected to offset any revenue loss stemming from the decline in its legacy product.

1. In the first, nevertheless unlikely scenario, Dialogic finds a new lender to extend them $90 million with manageable terms. Covenants of minimum liquidity, minimum EBITDA, minimum interest coverage ratio, and maximum consolidated total leverage ratio must fit Dialogic's current growth patterns. With a new lender, Dialogic could continue with business as usual. Guidance for 2011 and a revenue multiple of 2 would peg the stock price at $7.40.

There is upside potential in DLGC's shares. The merger has successfully gained the company market share and a strong operating margin. Mobile data and mobile broadband within emerging markets is in its infancy and DLGC is a good way to play the current telecommunication boom. At today's stock price of $2.39, covenant breach concerns will continue to drive the stock lower.