Bracing for Earnings Season

First-quarter earnings season in the tech world kicks off this week. Google (Nasdaq: GOOG) is scheduled to report its results after the market closes Thursday. Tech stocks have had a nice run during the past six months, so expectations are high, and many valuations are stretched. Companies are going to have to put up some solid first-quarter numbers and issue upbeat second-quarter guidance. In this environment, disappointments will be dealt with swiftly.

I’m cautious because there are signs of froth across the sector. Take NetSuite Inc. Shares of this cloud-based provider of ERP software have rebounded 104% since their Oct. 4 low of $25.32 to a high of $51.78. The company now sports a market cap of $3.45 billion and trades at a pricey 11.5 times the 2012 consensus revenue estimate of $298.4 million.

Part of NetSuite’s premium valuation can be tied to the fact that it is often mentioned as a takeover candidate, but I’m not sure who would step up to acquire the company at this price. NetSuite usually beats expectations. The sharp jump in the share price really applies the pressure to deliver stellar results. The consensus estimate calls for first-quarter revenue growth of 27% to $67.8 million.

Another recent winner is Allot Communications Ltd. (Nasdaq: ALLT), a provider of hardware and software that utilizes deep packet inspection (DPI) technology to help telecom service providers manage data over mobile and wireline networks. Last week, Allot shares hit a multi-year high of $24.42, representing a year-to-date gain of 61%. The stock has jumped 160% from its October low of $9.38.

Right now, Allot has a forward P/E of 44 (more than twice the expected 2012 EPS growth rate of 20%) and a forward price-to-sales ratio of 7.2. The company is expected to report respectable 2012 revenue growth of 20%, but that’s not the type of standout growth typically needed to support such a rich valuation.

Allot does have a promising longer-term outlook. According to the research firm Infonetics, the DPI market is expected to grow sixfold from 2009 through 2014 to $1.5 billion. Telecom operators use DPI for traffic shaping, subscriber controls, advanced network security, compliance, and targeted advertising.

With the increased use of smartphones and tablets, consumers are downloading, streaming, browsing, and sharing content on the go more than ever. Service providers face surging network use (and congestion) that does not necessarily translate into added revenue. Using service monitoring, operators can analyze how their subscribers are consuming network resources in real-time (and historically) to manage utilization and plan efficiently for capacity expansions.

Infonetics estimates that Allot has a 15% share of the DPI market, which is good enough for third place. Sandvine is in the top spot, with a 28% share, while Cisco Systems Inc. (Nasdaq: CSCO) is a close second, holding a 24% share. Arbor, part of the Tektronix unit of Danaher Corp. (NYSE: DHR), is in fourth place, with a 7% share. Procera Networks Inc. (Amex: PKT), in fifth place, controls 6% of the market. Procera shares have been big winners as well, jumping 50% so far this year to produce a forward P/E of 40. Competition will heat up this year as F5 Networks Inc. (Nasdaq: FFIV) rolls out its own DPI solution.