|Shares Out. (in M):||40||P/E||30||16|
|Market Cap (in $M):||602||P/FCF||23||12|
|Net Debt (in $M):||-132||EBIT||20||38|
Quantenna Communications, Inc. (QTNA) is an overlooked semiconductor designer for WiFi applications in the Residential, and to a lesser extent, Enterprise markets. The company makes chipsets that go into devices such as gateways, repeaters, set-top boxes, modems, and enterprise access points. Despite having some positive analyst coverage, trading $5 million per day (350,000 shares at a $15 stock price), and recording 20%+ revenue growth rates the past four years, the company remains undiscovered and undervalued with a modest valuation of 1.7x Enterprise Value to Revenue and 16x earnings. As discussed later, we feel that there is 100% upside to the shares from these levels.
Quantenna is the technology leader in the WiFi chip space, outpacing its main competitors, Broadcom (AVGO), Qualcomm (QCOM), and Marvell Technology (MRVL). The main criteria used to judge chips in this space are superior network speed, broad coverage area, and high capacity and reliability. Quantenna chips are currently best in class on all of these criteria.
WiFi specifications are standardized by the Institute of Electrical and Electronics Engineers, or the IEEE. This standardization is necessary so all of your WiFi enabled devices can talk to the relevant gateways and access points. The most recent standard is called 802.11ac and the upcoming standard is called 802.11ax, or WiFi 6 for short. While these standards specify many of the features of the technology, much of the implementation is left to the chipset companies themselves. That is how Quantenna can differentiate itself from the competition, even within a standardized framework.
One technology Quantenna uses is known as Multi-User, Multiple Input, Multiple Output, or MU-MIMO which allows the gateway (or other device) to communicate with many users at one time. Another technique is known as beamforming, where the signal is concentrated in the direction of the user rather than being spread out in all directions. This technology increases the bandwidth, or speed, for each user’s connection. Quantenna was first to market with a 4x4 MIMO which uses 4 antennas to generate 1G user speeds. Soon thereafter the company was first to market again with an 8x8 MIMO which generates 10G user speeds from 8 antennas. The company’s main competitors have not been able to duplicate the 8x8 MIMO technology to date. As such, Quantenna owns the 10G market currently and has used that to its advantage in locking up the market’s largest design win with Comcast.
The Comcast design win includes 25 million Comcast subscribers and another 10 million subscribers from a syndicate of buyers tagging along with Comcast including Shaw Communications, Cox Communications, Rogers Communications, and Videotron Ltd. Each Comcast gateway contains $13 in content from Quantenna (syndicate ASPs are a little higher), rendering a $455 million total value to the contract, or about $91 million per year. The company is still ramping the project up to full value but should be there by the second half of 2019. In a follow up to Comcast, Quantenna recently won a Deutsche Telekom tender for a high-end gateway it is producing. Deutsche Telekom wants to use Quantenna’s 8x8 MIMO chipset to maximize speed for its subscribers. This tender is only targeting the high end of DT’s subscriber base so will be much smaller initially but has ample room to grow over time.
Qunatenna’s strategic plan is to start at the high end of the market and then as time goes by and faster products emerge, use its older products to target the mid-range of the market which is much bigger in terms of units. The company is just getting to that stage now where its products released 3 years ago and cost-reduced over time are ready for the mid-market. The company calls this initiative “Spartan” and already has a number of design wins with it. ASPs for these products are in the $6-7 range, but are still near corporate average on the gross margin line. The Spartan products also open up new geographies for the company. Whereas so far Quantenna’s sales have been mainly in the Americas and Europe, a lower cost product will open up Asian countries such as China, Singapore, and Vietnam. The sum of the potential subscribers in these markets is huge in size and could easily double the addressable market for Quantenna.
In 2018, Quantenna will end the year with about $220 million in revenue, a 49.7% gross margin, and a 9.1% operating margin. We feel that the company’s operating expenses are highly leverageable with revenue growth and if revenue continues to grow at a 20% pace, operating margins will rapidly improve. For 2019, we expect $271 million in revenue, 50.4% gross margins, and a 14% operating margin. Finally for 2020, we expect $320 million in revenue, 51% gross margins, and 17.4% operating margins. The company thinks it can achieve ultimate operating margins in the 20-25% range.
Management at the company is very solid. Sam Heidari, the company’s CEO, has vast experience leading chip companies including Doradus Technologies which he sold to Ikanos Communications, where he became CEO. He has a PhD from USC in Electrical Engineering. Sean Sobers, the company’s CFO, formerly worked for seven years as vice president of finance at Cadence Design, and prior to that at Polycom. The company, most importantly, has an innovative team of chip designers which has enabled it to bring differentiated chips to the market.
What are the possible endgames for Quantenna? There is sufficient room in its addressable market for the company to grow at a 20%+ rate for an extended period of time, especially if it taps the mid-range of the market as well as the high end. On the other hand, if any of its large competitors, Qualcomm, Broadcom, or Marvell wanted to effectively address the high end of the market, they could easily purchase the company with their ample financial resources.
On a standalone basis, we estimate the company will earn EPS of $1.38 in 2020 on revenue of $320 million. This revenue assumes 20% annual growth in 2019 and 2020. Given the company’s revenue growth rate and room for margin expansion, we feel a 20x P/E multiple is reasonable. This would result in a $30.50 stock price or about 100% upside from current levels.
Revenue and EPS outperformance will cause multiple expansion. There is also the possibility of a takeout by a larger player.