Sandvine (SAND)

Complaints that the US cable provider, Comcast, is blocking file-sharing have been running on broadband user forums since the summer, but gained credence in October when Associated Press tested critics’ claims. Two out of three attempts to download an electronic copy of the King James Bible failed on a Comcast network.

The results may be anecdotal and so-called 'traffic shaping' isn’t uncommon among internet service providers. A study by another provider of bandwidth management technology claimed that people sending each other music and video files sometimes accounts for 80 per cent of internet traffic. Sandvine’s main pitch is that its technology can ensure this doesn’t clog up the network and impair the performance of really speed-sensitive applications, such as internet telephony or online videogaming.

Nevertheless, criticism of Comcast for its alleged traffic shaping is mounting, even reaching the law courts and the US presidential debate. In mid-November, a Californian sued Comcast for falsely advertising an unlimited broadband service. And the leading Democrat presidential candidates, Hillary Clinton and Barak Obama, have both pledged support for a 'net neutrality' law, which would render traffic-shaping illegal.

Comcast has consistently denied it filters its networks, and does not name its technology suppliers for commercial and network security reasons. Sandvine doesn’t name customers either, adding that none of its customers 'block'' a particular application, merely allocate network resources fairly.

But Comcast has been named by City analysts as the largest commercial deployment of Sandvine’s deep-packet inspection (DPI) technology. In its third-quarter results, Sandvine said its largest customer (which is widely believed to be Comcast) made up 54 per cent of sales in the year to date. That’s down from 73 per cent in the first nine months of last year, but it is still a disproportionately large weighting towards just one customer. It's always worrying if a company relies heavily on a few customers. And, in Sandvine's case, the concern is magnified if Comcast has a potential public-relations crisis on its hands.

If net neutrality legislation were to be introduced, Sandvine says that its 'bandwidth management' technology would still be used to filter out security threats - for example, PCs hijacked by hackers to send out spam - or to help high-priority applications such as gaming and telephony on the internet. Nonetheless, a law might be a barrier to growth of DPI technology.

At least there is little sign of a slowdown so far at Sandvine, which supplies 13 of the world's top 100 telecoms providers and raised its revenue forecasts for the year just ended when it announced third-quarter results in October. But deals outside North America have been patchy since the end of 2006, with sales from reselling partners set to miss previous forecasts, and gross profit margins fell from 80 per cent to 74 per cent. Larger rivals - such as Cisco, which makes a broad array of networking equipment for carriers - are undaunted by the current debate over traffic shaping, as they push harder into the DPI space.

With Sandvine's revenues set to double in both 2006-07 and 2007-08 (according to analysts at Citi Investment Research), it’s perhaps not surprising that its shares trade on a heady 34 times 2007’s forecast earnings and 27 times 2008’s. But that rating fails to discount the risks of customer concentration, especially when Sandvine's biggest customer might soon have a strong incentive to restrict the use of Sandvine's technology. Sell.

BEAR POINTS

Heavily reliant on one customer, Comcast

Comcast faces complaints over 'network filtering'

Threat of 'net neutrality' legislation

BULL POINTS

Leading technology in fast-growing market

Winning more “tier 1” customers