Polycom: Is The Stock Of This Videoconferencing Leader Overheating?

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Since I first recommended Polycom (PLCM) in September 2010 in my previous Inside Wall Street column at AOL DailyFinance, its stock has skyrocketed by 155%, to $31 a share. At the time, Wall Street ignored the stock of the maker of videoconferencing equipment, and you could hardly find anybody recommending it. Street analysts were either neutral on the stock or rated it as “underperform.” Now that the stock is hitting new highs, droves of analysts are hot and bullish on the stock.

 But several big bulls on Polycom have now turned bearish, suggesting that at its current lofty level, the stock has become overpriced -- and could only head lower.

“Trading at 30 times estimated 2011 earnings, the stock is now selling at its highest price-earnings ratio ever and leaves no room for any disappointment, so investors should sell it if they own shares,” says Greg MacArthur, president of consulting firm Viewpoint 2000.

Previously a big fan of the stock, MacArthur says that with the stock market currently showing signs of weakness, Polycom will get its share of the downdraft as investors react to the market’s decline.

A SLOWDOWN IN THE SECOND HALF

MacArthur expects the stock to drop by as much as 30% from its current price, and says that based on estimated 2012 earnings, the stock is already fully priced.

He expects that second-quarter earnings would still be up from a year ago but that results in the second half would indicate a slowdown in earnings growth.

“In my 30 years on Wall Street, this is the first time that I am taking a rather substantial profit from one stock that has had its biggest move in 10 years,” says MacArthur. He first bought shares in 2005 when it was trading at a split-adjusted $6.50 a share. At its current price, Poycom has jumped by a stunning 450% since then, he notes.

 Zacks Investment Research on July 11 downgraded Polycom from a buy to neutral, based on its high valuation, noting that the stock has soared 155% in a year. “We believe Polycom is fairly valued” based on its current price, says Zacks in a report. However, it acknowledges that the long-term fundamentals of video-conferencing industry remain compelling.

A big player in the industry is Cisco Systems (CSCO), which has been expanding its reach in videoconferencing. Despite facing competitive pressure from Cisco, says Zacks, Polycom’s high-margin Network Infrastructure Systems businesses grew 25% in the previous quarter. Part of Polycom’s growth has been driven by acquisitions.

Analyst Ari Bensinger of Standard & Poor’s, rates Polycom a hold and forecasts that sales will increase 22% in 2011, following a 26% rise in 2000. Strong demand for video communications equipment and network solutions are driving the high level of sales -- and are aided by its partnerships with Hewlett-Packard (HPQ) and Microsoft (MSFT). Bensinger has a modest price target of $34 a share.

Bensigner believes that video communications solutions are fast becoming business-spending priorities due to their compelling return on investments as they help reduce costly travel expense and improve employee efficiency. He forecasts split-adjusted earnings of 88 cents a share in 2011, and $1.15 in 2012, up from 2010’s 39 cents.

Those factors, to be sure, are some of the reasons why analysts remain generally bullish on Polycom. They expect more partnerships will be formed by Polycom with other big tech companies, including International Business Machines (IBM).

Nonetheless, MacArthur thinks the analysts are too optimistic on their price targets and earnings estimates. The stock’s price-earnings multiple will “suffer a contraction because the company’s fast growth rate can’t be sustained through 2012,” he argues.

MacArthur predicts the stock will drop to the low 20s as most analysts haven’t factored in any possible slowdown in the company’s growth. Nor have they been able to justify the rapid rise in the stock’s price-earnings ratio, he says.

So if MacArthur and the bears are right, Polycom’s shares should stumble and trek lower before they could push much higher.