AVIAT NETWORKS INC AVNW
August 25, 2010 - 10:41pm EST by
ithan912
2010 2011
Price: 3.80 EPS $0.13 $0.25
Shares Out. (in M): 60 P/E 29.2x 15.2x
Market Cap (in M): 227 P/FCF 13.0x 9.0x
Net Debt (in M): -137 EBIT 10 20
TEV: 90 TEV/EBIT 9.0x 4.5x

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Description

 

Investment Thesis

AVNW is an excellent opportunity to invest in a leading wireless backhaul producer at 19% EV/Sales and below tangible book value, while backhaul traffic continues to grow rapidly, bookings have bottomed and North American business activity begins to pick up.     AVNW has a very overcapitalized balance sheet with $137mm of net cash ($2.30/share) as of 6/30, a returning CEO who has tremendous knowledge and background in the business, and a new cost cutting program that will boost operating margins inline with business conditions and yield sustainable profitability at current trough revenue levels.  Not to mention a recently announced active 6% shareholder Ramius, which outlines the opportunity well in a recent 13D filing.  I believe an investment in AVNW today has very little downside risk and 100%+ upside potential over next 1-2 years.  Last night's quarterly results and large guidance range for next quarter may provide a great entry point tomorrow.

Business

Developed market wireless subscriber growth appears to have stalled, but developing markets are growing rapidly and in many cases, the entire telecom infrastructure is wireless, providing a nice tailwind for Aviat.  The keys for Aviat are new network placements and add on capacity as backhaul bottlenecks continue to occur globally.  60% of Aviat's revenue is outside of North America currently, with Africa revenue being volatile the last 2-3 years as only 2 real customers historically and consolidation of carriers has hurt Aviat.  Europe is having problems and it appears both it and Africa are currently losing money in their operations.  Russia activity is picking up and is a key region for AVNW.  Asia Pac continues to grow and management is optimistic in its future and ability to generate sound profitability, albeit exact margins there now are tough to determine.  The 10k breaks out North America vs. International operators and it appears N.A is breakeven, but a lot of costs associated with N.A. are really International given AVNW is based in CA and a lot of corporate costs associated with running the International ops are baked into the N.A. #s.  Tough to say how much but management acknowledges this issue. 

The general consensus is networks are moving rapidly to 4G/LTE, however, in reality Aviat believes there still exists a very large market for TDM/3G equipment, as voice uptime is more critical than data uptime.  Aviat is very strong in TDM and will continue to leverage this as they build out there 4G/WIMAX abilities, given backhaul networks require more and more traffic provisioning - cellular base station traffic is up 10 fold in 3 years and expected to double every 2 years, according to Yankee Group. 

There is quite a bit of competition in this area with Ceragon and Dragonwave being 2 pure play comps and obviously Ericsson and Alcatel/Lucent.  Ceragon is a very good competitor with strong product portfolio and have been aggressively recruiting Aviat personnel, especially in sales.  Huawei in Taiwan has been a thorn in the industry's side so to speak as Bank of China has offered them absurd financing and Huawei is financing their sales at or below cost, trying to capture market share.  It has hurt industry pricing but can't last forever.  Customers are aware of this and continue to want multiple vendors.

Generally customers seem happy with Aviat (candidly, have only talked to 2 and most feedback is from analyst community), continue to require multiple vendors and Aviat should get a nice share of the market going forward given its strong customer list, global footprint and competitive product portfolio. 

The new CEO Chuck Kissner was the CEO of Stratex Networks and due diligence on him over the last few weeks has come back pretty positive.  He seems to be a no nonsense guy who realized the cost structure was too bloated for current business conditions and has an aggressive plan in place to adjust it the next few months.  He has been there a month but knows from the board level that many investors were fed up with Harold's growth ambitions that weren't in sync with customer's spending plans and the overall economic environment. 

Recent changes

New strategic plan highlights and cost cutting program, per last night's release and conference call:

  • Focus on wireless transmission and their microwave backhaul solutions, where they have a strong presence and portfolio
  • Make WIMAX part of the wireless product offering, not a separate business.
  • Expand its service businesses - network mgmt, design, implementation
  • Achieve profitability on current revenue run rate levels of $110-120mm per quarter
    • Reduce overall cost structure by $30-35mm annually; $6-8mm per quarter in SG&A and rest in COGS through manufacturing efficiencies.

The company took major charges this quarter and made it a kitchen sink quarter - dropped intangibles $71mm and PP&E $10mm, sold TX manufacturing facility, announced plans to close Raleigh facility and are moving to a 100% outsourced manufacturing model.  D&A will drop $12mm annually as a result.  Moved to Santa Clara - will save $1.5mm annually, took $2mm of cash to do it however but still a smart move.

Company produced $28.3mm of operating cash flow in FY2010 (June), lower than previous years but decent given poor operating performance and bloated cost structure.

$10-12mm of cash will be burned to complete this restructuring, mainly over next 2 quarters.  Gross margins will be weak in the 1Q due to scrap inventory charge on India WIMAX equipment, but will return to 32-33% range by 2H.  If not for this charge, GM% would be up QoQ over last quarter.  OPEX was $43mm last quarter and will be down $6-7mm by Q311 (3/31/11).   

Worst case, if not turned around and successful by end of next year, I see 2 scenarios:

1)     Deemphasize WIMAX altogether and shun Telsima acquisition operations, focus purely on TDM/3G microwave business that continues to be the core and most successful product offering, thereby reducing costs even further; or

2)      Close down Africa and Europe, focus on North America and AsiaPac, dramatically reducing cost structure and running a 10% EBIT margin, albeit on $250-300mm of revenue.  Less growth prospects, but highly profitable.  This is a drastic move and most likely wouldn't happen until 2012.  Shareholder pressure may also cause this or a cleanup of the business to dress it up for a sale to strategic.  Private equity would also be interested, especially today, but shareholders wouldn't be rewarded enough as private equity would want the upside of the cost cuts and restructuring.  

Balance sheet/Liquidity

Pristine condition with $137mm of net cash, $189mm of net working capital (current asset minus total liab) and $80mm untapped credit facility.     

Buyback would be a good use of cash and board has considered it, as well as tuck in acquisitions, but neither is in the cards for now until business turns and cost structure is reset.  If stock doesn't respond in a reasonable amount of time, I fully expect the board to feel pressure to consider a sale to either a strategic like Juniper or Cisco, or to private equity worst case, both of which should be at nice premiums to today's quote. 

Valuation

$500mm revenue business with 33-35% gross margins and nice medium-long term prospects for $90mm enterprise value.  Stock has traded on balance sheet value principally the last few months and appears to have bottomed.  Once cost cutting is complete and assuming revenue stays flat, AVNW should do $40-50mm of EBITDA on $450-500mm in revenue.  Did $20mm on $479mm last year, plus $30-35mm of cost reductions.  This would be conservative as management fully expects to grow revenue in the future given backhaul traffic growth and excellent microwave product portfolio and R&D team.  At 6x, $270mm EV would yield $6.62/share.  That is my base case.  D&A will be down $12mm annually so I am assuming $25mm in annual D&A and $15mm of annual capex, and 25% tax rate.  At $45mm in EBITDA, that would be $15mm in net income, or $.25/share, and $25mm in FCF or $.42/share. 

Please see below comp chart with Ceragon and Dragonwave.  Ceragon is a better comp as Dragonwave is principally a WIMAX business even thought they are focused on expanding.  DRWI blew up recently as its main customer Clearwire cut back its growth capex. 

    25-Aug       Net Wkg       LTM EV/LTM  
  Symbol Price Shares Mkt Cap Net Debt Capital TEV TBV LTM Rev EBITDA EBITDA Margin
Ceragon CRNT  $7.51 33.44  $251.1  $(69.5)  $142.1  $181.7  $167.0   $218.7  $13.75 13.21 6.3%
Dragonwave DRWI  $5.96 36.21  $215.8  $(110.5)  $130.9  $105.3  $138.6   $192.0  $42.79 2.46 22.3%
                         
AVERAGE                     7.84 14.29%
                         
Aviat Networks* AVNW  $3.80 59.7  $226.9  $(136.7)  $188.7  $90.2  $239.4   $478.9 $22.40 4.03 4.7%
                         
       * FY is June so 2010E is 6/11 FY and FY11 are non GAAP estimates, post restr charges, assumes 25% tax rate            
       * Assumes $25mm in D&A annually and $15mm of annual capex                

        EV/LTM Est Est 10E 10E EV/ Est Est 11E 11E EV/
    P/NWC P/TBV Rev 10E EPS 10E P/E EBITDA EBITDA 11E EPS 11E P/E EBITDA EBITDA
Ceragon CRNT  1.77 1.50 0.83  $0.48 15.78  $14.30 12.70  $0.66 11.47  $20.20 8.99
Dragonwave DRWI   1.65  1.56 0.55  $0.23 26.03  $10.31 10.21  $0.17 34.45  $9.87 10.67
                         
AVERAGE   1.71 1.53 0.69   20.90   11.46   22.96   9.83
                         
Aviat Networks* AVNW  1.20 0.95 0.19  $0.13 29.23  $35.00 2.58  $0.25 15.20  $45.00 2.00
                         
Equivalent    $5.40  $6.14  $7.82    $2.72    $9.01    $5.74    $9.70
Upside   42% 62% 106%   -28.5%   137.0%   51.0%   155.2%

Risks

-   Bookings remain soft in Africa and N.A. doesn't turn

-   Cost cutting cuts muscle, not just fat, hurting product portfolio, performance and company's reputation

-   Huawei continues to take share with unprofitable bids

-   Continued pushout of deal closings and supply shortages causes further revenue weakness below $110-120mm quarterly 

Catalyst

- Achieving cost cutting program in size and on target, generating profitable quarters once again
- Bookings and revenue growth return
- Market recognizes turnaround and growth potential, assigning a reasonable earnings and sales multiple
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    Description

     

    Investment Thesis

    AVNW is an excellent opportunity to invest in a leading wireless backhaul producer at 19% EV/Sales and below tangible book value, while backhaul traffic continues to grow rapidly, bookings have bottomed and North American business activity begins to pick up.     AVNW has a very overcapitalized balance sheet with $137mm of net cash ($2.30/share) as of 6/30, a returning CEO who has tremendous knowledge and background in the business, and a new cost cutting program that will boost operating margins inline with business conditions and yield sustainable profitability at current trough revenue levels.  Not to mention a recently announced active 6% shareholder Ramius, which outlines the opportunity well in a recent 13D filing.  I believe an investment in AVNW today has very little downside risk and 100%+ upside potential over next 1-2 years.  Last night's quarterly results and large guidance range for next quarter may provide a great entry point tomorrow.

    Business

    Developed market wireless subscriber growth appears to have stalled, but developing markets are growing rapidly and in many cases, the entire telecom infrastructure is wireless, providing a nice tailwind for Aviat.  The keys for Aviat are new network placements and add on capacity as backhaul bottlenecks continue to occur globally.  60% of Aviat's revenue is outside of North America currently, with Africa revenue being volatile the last 2-3 years as only 2 real customers historically and consolidation of carriers has hurt Aviat.  Europe is having problems and it appears both it and Africa are currently losing money in their operations.  Russia activity is picking up and is a key region for AVNW.  Asia Pac continues to grow and management is optimistic in its future and ability to generate sound profitability, albeit exact margins there now are tough to determine.  The 10k breaks out North America vs. International operators and it appears N.A is breakeven, but a lot of costs associated with N.A. are really International given AVNW is based in CA and a lot of corporate costs associated with running the International ops are baked into the N.A. #s.  Tough to say how much but management acknowledges this issue. 

    The general consensus is networks are moving rapidly to 4G/LTE, however, in reality Aviat believes there still exists a very large market for TDM/3G equipment, as voice uptime is more critical than data uptime.  Aviat is very strong in TDM and will continue to leverage this as they build out there 4G/WIMAX abilities, given backhaul networks require more and more traffic provisioning - cellular base station traffic is up 10 fold in 3 years and expected to double every 2 years, according to Yankee Group. 

    There is quite a bit of competition in this area with Ceragon and Dragonwave being 2 pure play comps and obviously Ericsson and Alcatel/Lucent.  Ceragon is a very good competitor with strong product portfolio and have been aggressively recruiting Aviat personnel, especially in sales.  Huawei in Taiwan has been a thorn in the industry's side so to speak as Bank of China has offered them absurd financing and Huawei is financing their sales at or below cost, trying to capture market share.  It has hurt industry pricing but can't last forever.  Customers are aware of this and continue to want multiple vendors.

    Generally customers seem happy with Aviat (candidly, have only talked to 2 and most feedback is from analyst community), continue to require multiple vendors and Aviat should get a nice share of the market going forward given its strong customer list, global footprint and competitive product portfolio. 

    The new CEO Chuck Kissner was the CEO of Stratex Networks and due diligence on him over the last few weeks has come back pretty positive.  He seems to be a no nonsense guy who realized the cost structure was too bloated for current business conditions and has an aggressive plan in place to adjust it the next few months.  He has been there a month but knows from the board level that many investors were fed up with Harold's growth ambitions that weren't in sync with customer's spending plans and the overall economic environment. 

    Recent changes

    New strategic plan highlights and cost cutting program, per last night's release and conference call:

    The company took major charges this quarter and made it a kitchen sink quarter - dropped intangibles $71mm and PP&E $10mm, sold TX manufacturing facility, announced plans to close Raleigh facility and are moving to a 100% outsourced manufacturing model.  D&A will drop $12mm annually as a result.  Moved to Santa Clara - will save $1.5mm annually, took $2mm of cash to do it however but still a smart move.

    Company produced $28.3mm of operating cash flow in FY2010 (June), lower than previous years but decent given poor operating performance and bloated cost structure.

    $10-12mm of cash will be burned to complete this restructuring, mainly over next 2 quarters.  Gross margins will be weak in the 1Q due to scrap inventory charge on India WIMAX equipment, but will return to 32-33% range by 2H.  If not for this charge, GM% would be up QoQ over last quarter.  OPEX was $43mm last quarter and will be down $6-7mm by Q311 (3/31/11).   

    Worst case, if not turned around and successful by end of next year, I see 2 scenarios:

    1)     Deemphasize WIMAX altogether and shun Telsima acquisition operations, focus purely on TDM/3G microwave business that continues to be the core and most successful product offering, thereby reducing costs even further; or

    2)      Close down Africa and Europe, focus on North America and AsiaPac, dramatically reducing cost structure and running a 10% EBIT margin, albeit on $250-300mm of revenue.  Less growth prospects, but highly profitable.  This is a drastic move and most likely wouldn't happen until 2012.  Shareholder pressure may also cause this or a cleanup of the business to dress it up for a sale to strategic.  Private equity would also be interested, especially today, but shareholders wouldn't be rewarded enough as private equity would want the upside of the cost cuts and restructuring.  

    Balance sheet/Liquidity

    Pristine condition with $137mm of net cash, $189mm of net working capital (current asset minus total liab) and $80mm untapped credit facility.     

    Buyback would be a good use of cash and board has considered it, as well as tuck in acquisitions, but neither is in the cards for now until business turns and cost structure is reset.  If stock doesn't respond in a reasonable amount of time, I fully expect the board to feel pressure to consider a sale to either a strategic like Juniper or Cisco, or to private equity worst case, both of which should be at nice premiums to today's quote. 

    Valuation

    $500mm revenue business with 33-35% gross margins and nice medium-long term prospects for $90mm enterprise value.  Stock has traded on balance sheet value principally the last few months and appears to have bottomed.  Once cost cutting is complete and assuming revenue stays flat, AVNW should do $40-50mm of EBITDA on $450-500mm in revenue.  Did $20mm on $479mm last year, plus $30-35mm of cost reductions.  This would be conservative as management fully expects to grow revenue in the future given backhaul traffic growth and excellent microwave product portfolio and R&D team.  At 6x, $270mm EV would yield $6.62/share.  That is my base case.  D&A will be down $12mm annually so I am assuming $25mm in annual D&A and $15mm of annual capex, and 25% tax rate.  At $45mm in EBITDA, that would be $15mm in net income, or $.25/share, and $25mm in FCF or $.42/share. 

    Please see below comp chart with Ceragon and Dragonwave.  Ceragon is a better comp as Dragonwave is principally a WIMAX business even thought they are focused on expanding.  DRWI blew up recently as its main customer Clearwire cut back its growth capex. 

        25-Aug       Net Wkg       LTM EV/LTM  
      Symbol Price Shares Mkt Cap Net Debt Capital TEV TBV LTM Rev EBITDA EBITDA Margin
    Ceragon CRNT  $7.51 33.44  $251.1  $(69.5)  $142.1  $181.7  $167.0   $218.7  $13.75 13.21 6.3%
    Dragonwave DRWI  $5.96 36.21  $215.8  $(110.5)  $130.9  $105.3  $138.6   $192.0  $42.79 2.46 22.3%
                             
    AVERAGE                     7.84 14.29%
                             
    Aviat Networks* AVNW  $3.80 59.7  $226.9  $(136.7)  $188.7  $90.2  $239.4   $478.9 $22.40 4.03 4.7%
                             
           * FY is June so 2010E is 6/11 FY and FY11 are non GAAP estimates, post restr charges, assumes 25% tax rate            
           * Assumes $25mm in D&A annually and $15mm of annual capex                

            EV/LTM Est Est 10E 10E EV/ Est Est 11E 11E EV/
        P/NWC P/TBV Rev 10E EPS 10E P/E EBITDA EBITDA 11E EPS 11E P/E EBITDA EBITDA
    Ceragon CRNT  1.77 1.50 0.83  $0.48 15.78  $14.30 12.70  $0.66 11.47  $20.20 8.99
    Dragonwave DRWI   1.65  1.56 0.55  $0.23 26.03  $10.31 10.21  $0.17 34.45  $9.87 10.67
                             
    AVERAGE   1.71 1.53 0.69   20.90   11.46   22.96   9.83
                             
    Aviat Networks* AVNW  1.20 0.95 0.19  $0.13 29.23  $35.00 2.58  $0.25 15.20  $45.00 2.00
                             
    Equivalent    $5.40  $6.14  $7.82    $2.72    $9.01    $5.74    $9.70
    Upside   42% 62% 106%   -28.5%   137.0%   51.0%   155.2%

    Risks

    -   Bookings remain soft in Africa and N.A. doesn't turn

    -   Cost cutting cuts muscle, not just fat, hurting product portfolio, performance and company's reputation

    -   Huawei continues to take share with unprofitable bids

    -   Continued pushout of deal closings and supply shortages causes further revenue weakness below $110-120mm quarterly 

    Catalyst

    - Achieving cost cutting program in size and on target, generating profitable quarters once again
    - Bookings and revenue growth return
    - Market recognizes turnaround and growth potential, assigning a reasonable earnings and sales multiple

    Messages


    SubjectDisruptions
    Entry09/03/2010 07:38 AM
    Memberrab
    How concerned are you about customer loss during the restructuring period? 
    Additionally, with peers poaching sales talent and Huawai pressuring pricing, it would seem as though sales could be vulnerable?  any additional thoughts there?

    SubjectStill following?
    Entry12/19/2013 02:48 PM
    Membermaggie1002
    Hi Ithan, wonder if you're still following and, if so, whether you can offer a brief update.  Stock seems to have been catapulted by recent filing of meaningful interest by Privet and then faded hard.  At under TBV (though TBV looks to be eroding more in the near-term), thought it might be worthy of consideration.  Thank you in advance for your perspective/insights.

    SubjectAVNW
    Entry12/21/2013 03:07 AM
    Memberjhu2000
    How do you get to 5-6? What strategic buyer do you envision?
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