|Shares Out. (in M):||9||P/E||17.3x||13.8x|
|Market Cap (in $M):||68||P/FCF||1.6x||10.5x|
|Net Debt (in $M):||-41||EBIT||8||10|
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Trading at 2.9x growing EBITDA, both The Company itself and its largest shareholder are competing to buy stock of this industry leader that recently expanded its market opportunity 20x.
1) Commands 50% share of its core audio conferencing market
2) Recently expanded its market opportunity 20x through the acquisition of VCON
3) Is uniquely positioned to exploit a paradigm shift in the video conferencing space
4) Recently won a net $23.5m after tax settlement resulting in 80% net working capital to market value
5) Recently announced a $10m share repurchase plan (15% of the company)
6) Received notice that largest shareholder wants special dividend and plans to increase his holdings pursuant to a 10b5-1 filed two weeks ago
7) Will generate $9.7m of EBITDA in ’13 resulting in 2.9x EBITDA
8) Would trade for $15 (100% upside) even after applying a 30% haircut to the average multiples of public peers and recent M&A transactions.
ClearOne Communications (CLRO or The Company) provides audio conferencing systems to large enterprise and organizations. CLRO’s systems provide clear, crisp, full-duplex audio for large venues such as auditoriums and board rooms, as well as desktops and small conference rooms. The Company’s products are typically integrated into complex unified communications (UC) systems by System Integrators.
Through its acquisition of VCON, CLRO entered the Video Conferencing space with a software solution which significantly expands its market opportunity and specifically exploits the paradigm shift happening now in the video conferencing industry.
LEVERAGING DOMINANT MARKET SHARE TO EXPAND INTO ADJACENT VERTICALS
According to Frost and Sullivan, ClearOne leads the market for installed audio conferencing endpoints with roughly 50% market share. Management has continually integrated new technologies into its portfolio and maintains market-leading pricing. We estimate that the core market for professional installed audio is roughly $65m p.a. and CLRO generates $32m of revenue from this market at very high margins. Including desktop and conference room audio endpoints, the overall audio opportunity is roughly $200m for CLRO. Within this TAM, CLRO has been able to generate $40-50m annual revenue at 15-20% EBITDA margins.
It is from this solid foundation that CLRO has added complementary technologies in adjacent verticals that can be sold through existing channels. With the acquisition of VCON last February, CLRO entered the HD Video Conferencing space and increased the company’s overall TAM by more than $4bn (20x traditional TAM). This significant leap in revenue opportunity means that even capturing 1% of the Video Conferencing market would nearly double CLRO’s revenue. What’s more, as we look out at the competitive landscape and tectonic paradigm shift in delivery platforms, we think that ClearOne is attractively positioned to capture a needle-moving share of the video space.
ATTRACTIVELY POSITIONED IN $4BN VIDEO CONFERENCING MARKET
There is a paradigm shift happening in the video conferencing industry from on-premise, hardware-based appliances to software-based and cloud delivered solutions. This has been a difficult transition for incumbent hardware providers and has allowed new entrants into the market.
The following are recent excerpts from video conferencing heavyweights:
Clearly the industry is in a transition as it relates to hardware-based to software-based video conferencing. I think there are companies that are offering a video-as-a-service or software-only product that are easy to implement and that are attractive to the CIO. Clearly it is a question of do I have to have a dedicated appliance.
-Polycom CEO, 17 May 2012
We’re seeing a new set of choices. What used to be traditionally hardware is now supplemented by software-based client options, infrastructure as a service or video collaboration as a service, etc. We’re starting to see CIOs pause and ask the question in the context of a pervasive rollout exactly how they fit in video collaboration and support the heterogeneous endpoint environment. It’s a combination of multiple factors creating the pause we’ve seen.
-Polycom CEO, 28 November 2012
I’m taking a hard look at whether we are the best owners of LifeSize given the evolving dynamics in the video conferencing space.
-Logitech CEO, 24 January 2013
The collaboration market is seeing a lot of market transitions. What’s happening is a lot of the value is increasingly moving from on-premise to software delivered from the cloud as a service.
-Cisco’s SVP of Video Collaboration, 12 March 2013
We think that CLRO is well positioned to capture share in the video conferencing market for several reasons. When it comes to capturing share from the incumbents:
1) CLRO doesn’t have to transition away from an existing appliance-centric model. Their entre is via software
2) Having video with audio is key. The channel wants full solutions. Meanwhile, CLRO’s video products are fully interoperable with leading systems
3) CLRO is already selling to the Enterprise with a widely recognized brand name and an existing channel
4) CLRO has a large SMB customer base which is underpenetrated and offers a sizable long-term growth opportunity
When it comes to outperforming newcomers (Vidyo, BlueJeans, etc.)
1) See #s 2 and 3 above
2) Prior to acquisition, VCON spent $100m and 10 years developing their system
3) CLRO just added Adi Regev as VP of Video Conferencing, stealing him away from Vidyo
4) CLRO’s is a comprehensive product suite rather than a standalone endpoint solution or cloud bridge
Polycom’s CEO validated CLRO’s position with his recent commentary (2Q12 Earnings Call): “Start-up companies in this space are at a disadvantage selling to the enterprise where interoperability and investment protection is critical.” CLRO is a highly recognized brand name at the enterprise level and their products are fully interoperable!
As an aside, this transition reminds us of another industry undergoing a shift from on-premise appliances to cloud-delivered solutions. DGIT has servers behind the firewall in thousands of TV affiliates around the country and is #1 in delivering advertising spots. Its founders left the business, waited out their non-compete period, and formed ExtremeReach, delivering spots in the cloud at a fraction of the price. DGIT refuses to acknowledge the transition which has contributed to its stock falling substantially over the last few years. Given the precipitous fall, we tend to like DGIT down here but the moral for us is that once this type of transition takes hold, an industry will quickly re-contour to include new technologies. The good news is CLRO is positioned on the winning end of the transition.
RECORD REVENUE, NEW PRODUCTS, EXPANDED CHANNEL
CLRO conservatively recognizes revenue on sell-through to the end customers. After a poor start to 2012 along with the entire industry, CLRO’s 4Q12 revenue came in at record levels with the Video segment growing almost 50%. This is promising as CLRO launched its new line of COLLABORATE video conferencing products at InfoComm in mid-June. CLRO has also been refreshing its audio lineup, unveiling a new Digital Wireless Microphone System which will complement the existing Pro product lines and, management believes, will drive incremental system demand.
We have also seen momentum in distributor relationships. Since CLRO’s COLLABORATE family of products was introduced, the Company has announced the following:
2/26/13 – NewComm now distributing full line of software-based conferencing solutions
1/29/13 – VSO Marketing now distributing full line of software-based conferencing solutions
1/22/13 – Starin Marketing now distributing full line of software-based conferencing solutions
12/6/12 – D&H to distribute conferencing solutions and USB, analog, and VoIP conference phones
10/22/12 – Ingram Micro to distribute conferencing solutions and USB, analog, and VoIP phones
We note that both D&H and Ingram Micro mark CLRO’s development of the IT channel, where it did not previously have a presence. This is a large, untapped opportunity as Audio/Video converges with IT.
Further, management’s comments have been extremely positive. Short of giving forward guidance, CEO Zee Hakimoglu stated that she expects the positive 4Q12 momentum to be sustained and further propelled.
Despite significant progress made with respect to market opportunity, products, and distribution, CLRO’s enterprise value is well below its long-term average.
STRENGTHENED BALANCE SHEET LEADS TO COMPETITION FOR SHARES
CLRO landed a $45m settlement from UBS in December. The result was sealed however, until a similar lawsuit against Morgan Stanley was concluded. After paying a 15% fee to Lawyers and accruing for taxes on the net, CLRO ended up with $23.5m which, when added to existing cash balances and cash flow generation, results in $40.7m of cash. Net working capital represents 82% of CLRO’s market value.
Prior to the settlement, the Board of CLRO had instituted a $3m share repurchase program. Following the settlement, on February 21, the authorization was increased to $10m, or roughly 15% of the company at today’s prices. This apparently irked CLRO’s largest shareholder, Edward Bagley (former Board Chair, father of director Bryan Bagley, 30% holder). Whereas we typically see insiders enter into 10b5-1 plans to systematically sell stock, Ed Bagley filed a 10b5-1 to buy more. He also filed a 13-D demanding a one-time dividend.
Over the last seven years, CLRO has reduced share count by over 25% through stock repurchases.
In the past few quarters, inventory has been higher than management wanted it. Previously, The Company noted that monetizing its inventory wouldn’t be cost effective and that levels remained inflated due to CLRO’s preferred vendor status with VARs. After a $2.7m sequential decline in 3Q12, the inventory balance fell a further $1.6m in 4Q12 and CFO Narsi Narayanan stated there is further room to optimize as it steadily draws down $500k-$1m per quarter going forward.
GROWING SALES/EARNINGS, SEVERELY DEPRESSED VALUATION
We strip out VCON revenue from 2012 and assume the core business grows 4%, in line with PCLM (though we think it can grow faster). We add $4m, an average of $1m per quarter for video. Video was at a $600k quarterly run rate in 4Q before the channel was filled or fully trained. This results in a $50.4m top line in 2013.
We use a 60% gross margin, in-line with the long-term average (sans 2H12 inventory write-down) and that which CLRO manages the business for. Management has also guided to 60% as a long-term sustainable margin.
We keep S&M constant at 17.5% of revenue, give R&D a bump up, and get a meaningful reduction in G&A as legal fees and litigation bonus go away. The result is $9.7m EBITDA remaining conservative line-by-line, or 2.9x EBITDA.
We view EBITDA as meaningful given that The Company is amortizing acquisition-related intangibles and that the capital structure is clearly out of balance. On a cash flow basis, we think CLRO will generate $7.2m CFO (before any positive effects of working capital as they draw down inventory) and capex runs about $500-700k per annum. As such, CLRO is trading ~4x EV/FCF. Looked at another way, taxing EBITDA at a 37% rate results in $6.1m NOPAT, or 4.5x EV/NOPAT.
Note: We use 9.2m shares, a $7.45 price, and net $14.8m of deferred tax liability with the $55.5m cash position to arrive at a $27.8m adjusted enterprise value.
We think that a leader in its respective niche, with compelling opportunities for growth, well-positioned to capture market share from incumbents, generating significant, sustainable, and growing cash flow should command a valuation closer to its peers. If we apply a 30% haircut to the average peer multiple on either sales (of unprofitable peers) or EBITDA (of profitable peers), we arrive at a valuation 100% higher than today’s.
Mid-decade, CLRO held $12.2m in ARS from UBS and Morgan Stanley, which turned out to be illiquid. In 10/08, CLRO accepted offers to repurchase the $12.2m at PAR but did not waive any claims for consequential damages. CLRO subsequently sought damages as a result of their inability to access funds invested in ARS that UBS and MSCO had sold them, including losses with respect to a planned strategic business acquisition and related due diligence costs. The settlement was paid in December 2012, but not announced until January 2013. As such, the value is reflected on the 4Q12 balance sheet.
This report is neither a recommendation to purchase or sell any securities mentioned. The authors may or may not have a position in any security discussed in this report. Further, the authors may buy or sell shares in any company mentioned, at any time, without notice. The information contained herein is believed to be correct as of the posting date. Readers should conduct their own verification of any information or analyses contained in this report. The authors undertake no obligation to update this report based on any future events or information.
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