Telecom Infrastructure Play Dogs Engineering Company

Corporate Focus
by Anthony Palazzo

Nearly five years ago, Tetra Tech Inc. Chief Executive Li-San Hwang had a good idea. Anticipating what turned out to be a boom in telecommunications services, Hwang positioned his Pasadena-based engineering and environmental services firm to build the facilities that would house all the new gear.

"If you want to survive, you've got to follow the trend," Hwang said at the time. He began by buying two small telecommunications services firms, and he continued buying small-to-medium firms throughout the boom, adding companies that expanded Tetra Tech's service capabilities and its geographical reach.

The effort paid off well for Tetra Tech for a while, but now the firm is suffering from a steep fall-off in demand for these very same services. "Their focus in communications-related infrastructure design and buildout was a demand wave that lasted for a few years, said Joseph Vafi, a Robertson Stephens analyst. "It was and probably still is over the long term a good business to be in. Right now, however, that sector is really retrenching."

From less than $10 million in revenues for the year ended Sept. 30, 1997, Tetra Tech's communications business grew to about $185 million in the year ended Sept. 30, 2001, making up about 25 percent of the overall business.

But now some customers building telecom networks have gone out of business. Other telecom firms have been hoarding cash because it's so tough to raise money in capital markets. The ones who can afford to build are no longer racing to do so because of a decrease in competition. Also, particularly in the wireless area, subscriber growth hasn't met expectations.

"Combine those four factors and you're looking at a marketplace that's not feeling the urge to increase their capital spending, at least early in the year," said Richard C. Eastman, a Robert W. Baird & Co. analyst.

The drop-off has been steepest since the beginning of the year. On Jan. 16, the company issued first-quarter earnings and said it expects to report earnings of 24 cents per share in the second quarter ending March 31, on revenues between $198 million and $208 million. But on March 6, after a Baird downgrade and a dip in its stock price, the company said it is "evaluating its business outlook in (the communications) market and will update investors as more information becomes available."

Meanwhile, Tetra Tech's stock has fallen 58 percent, to a recent price of $14.16. Its 52-week high is $25.06.

Company officials did not return calls seeking comment, but analysts believe that the communications sector is now down to 20 percent or less of Tetra Tech's business, from perhaps 30 percent or more at the peak of the telecom wave.

Other divisions grow

Acquisitions have played an important role in Tetra Tech's revenue and earnings growth. Along with communications, the company's other two businesses also grew environmental services and infrastructure projects such as freeways and water-treatment systems. In the past five years, company-wide net revenues increased to $730.1 million from $190.8 million. Net income rose to $30.8 million from $14.3 million.

The company's management team earned high marks for integrating its acquisitions well and generating reliable profit margins. In fact, analysts have come to depend on Tetra Tech to keep acquiring smaller companies, because each acquisition can be used to extrapolate higher profit forecasts.

"Tetra Tech's been a well-managed company since it's gone public so the margins have always been good," said Eastman. "If you assume margins were to stay in the 11 to 13 percent range, it becomes very much a revenue story. To grow the earnings at a double digit rate, you have to grow the revenues.

Therein lies the rub. While its environmental and infrastructure businesses are sound, the communications market is struggling. As it manages through this difficult period, Tetra Tech's acquisition pace has slowed, and analysts have accordingly lowered revenue and profit forecasts for the year.

Eastman sees a rebound in the telecom market, but not until 2003. "For outsourcing companies like Tetra Tech, unfortunately you're going to have to sit against the ropes and take a few punches here, and wait out the market a little bit," he said.

Financial Editor Anthony Palazzo can be reached at 323-549-5225, ext. 224, or at

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