RELM WIRELESS CORP RWC
February 20, 2013 - 5:08pm EST by
Lukai
2013 2014
Price: 1.75 EPS $0.15 $0.27
Shares Out. (in M): 14 P/E 11.5x 6.6x
Market Cap (in $M): 24 P/FCF 5.8x 5.3x
Net Debt (in $M): -6 EBIT 3 4
TEV ($): 18 TEV/EBIT 5.7x 4.9x

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  • Wireless Communications
  • Manufacturer

Description

RELM Wireless is close to a net/net with meaningful growth and a high-teens FCF yield. The business is at an inflection point as its new product family addresses a substantially larger addressable market and its revenue base broadens. Despite a larger growth opportunity than ever before and significant organic revenue growth and margin expansion, RELM's current enterprise value is near historic lows.

RELM Wireless:
1. Serves a growing market with strong demand drivers
2. Recently tripled its market opportunity with its new family of products
3. Has been winning high profile customers, growing much faster than peers
4. Is demonstrating significant operating leverage; more than 50% of the incremental dollar falls to the bottom line
5. Has 90% of its market value in cash and net working capital
6. Generates a 19% FCF yield (2013)

The Company
RELM Wireless ("RWC") makes two-way land mobile radio (LMR) products used for handheld (portable) and vehicle (mobile) communications. In addition to radios, its products include base stations (improve radio performance by enhancing signal, etc.), repeaters (expand range of mobile radios) and related subsystems. LMRs are commonly used by the public safety sector (e.g., police, fire, and emergency responders) and government agencies.

The Company offers products under two brand names: BK Radio and RELM. Generally, BK Radio products serve the government and public safety market, the substantial majority of RWC’s revenue. BK Radio products are high-spec LMRs for professional radio users primarily in government and public safety. The BK Radio brand includes the next-generation KNG (“King”) product line which has significantly expanded RWC’s market opportunity.

RWC offers radios with high-specification performance, durability and reliability at a low cost relative to comparable offerings.

Insiders own 15% of the common stock.

Growing Market with Strong Demand Drivers
Market demand for RWC’s products is strong and being driven by technological innovations, government mandates, and an aging mission-critical infrastructure.

Aging Public Safety Radio Infrastructure: There is a considerable movement to migrate from analog radios to digital. Of the 40 million professional and commercial radios worldwide, 10% or less are digital. A recent Barron’s article revealed that 44% of municipalities hiked expenditures on public safety despite tight local budgets. RWC’s products are comparable in quality, reliability, performance, and features at a substantially lower price than the competition. RWC’s average BK Radio package costs $1,350 vs. Harris’ average of $2,100 and Motorola’s average of $2,650; a 36% and 50% discount, respectively with no trade-off in quality, reliability, ease of use, battery life, etc. As such, we believe that aging infrastructure is a driver for the industry, while fiscal responsibility is a driver for RWC.

DHS Tactical Communications: “TacCom” is a $3bn program released in March 2012 with a two-year base period and three one-year options through 2017. The purpose of this contract is to facilitate procurement of P25 land mobile radios (LMRs) while leveraging the buying power of the DHS and other agencies to foster a competitive, technology-neutral environment. RWC’s agents were successful in obtaining a “Small Business Set Aside” wherein small businesses are considered independent of large business proposals. This opens the door to a more level playing field through guidelines assuring that qualified small suppliers are the beneficiaries of a portion of the equipment procurements. Other agencies are able to procure under this vehicle including the White House Communications Agency, Department of Interior, Department of State, and Department of Justice.

APCO P25: “P25” is a collaborative project to ensure that two-way radios are interoperable. Varying protocols and spectrum make it difficult for Public Safety responders to achieve communications interoperability. This was painfully evident during the disasters that the US faced over the last 10-15 years. For example, fourteen minutes after a hijacked airliner plowed into the World Trade Center’s North Tower on Sept. 11, 2001, the Port Authority Police Department radioed orders to evacuate the entire complex in lower Manhattan. That order wasn’t heard by the deputy fire safety director in the South Tower, whose radio operated on different frequencies. Three minutes later, a second airplane hit his tower. Although P25 has been around for decades, P25 adoption has accelerated only in recent years.

Significant Increase in Addressable Market
RWC has its roots in VHF (low frequency) selling to federal customers like the Department of Interior and the US Forest Service. Product cycles tend to last 7+ years and have been lengthening. Over the past several years, RWC has rolled out the KNG (“King”) family of richly featured P25 radios that address the majority of the federal, state, and local public safety markets. State and local public safety is a large opportunity.

The introduction of their first UHF (higher frequency) KNG products in the ‘08/’09 timeframe and their first 800 MHz public safety radio allowed RWC to begin seeding the market with their portable product. During this time period, RWC also introduced their first KNG Mobile Radio on the VHF spectrum; UHF versions followed in 2011.

RWC took the further step of developing their own trunking technology rather than relying on a third-party license as most competitors do. This drives margins and profitability ahead of the competition and keeps competitors out of their system.

In June 2011, the KNG Series radios were validated under the P25 Compliance Assessment Program (CAP) as being interoperable with competitors’ communications network infrastructure. Having been validated on the infrastructure of four main providers, RWC’s KNG product line was included on the Responder Knowledge Base (“RKB”). The purpose of this was to provide federal, state and local emergency response agencies with evidence that the communications equipment they’re purchasing meets P25 standards for performance, conformance, and interoperability. For RWC’s sales efforts to be effective, this was an important step to help customers understand that the KNG products will work on their existing systems.

The KNG line now boasts >100 SKUs and RWC has plenty of manufacturing capacity to ramp up volumes. With this feature-rich family of radios, in-house trunking technology, CAP certification on existing infrastructure, and the RKB stamp of approval in place, RWC successfully tripled their market opportunity by late 2011:

Total & Addressable Markets $bn
   Global Market 9.0
   North American Market 5.0
   North American Terminal Market 2.4
   North American Conventional Terminal Market 1.0
   North American Trunking Terminal Market 1.4
   
   RWC Conventional Markets Addressable 0.7
RWC Markets Addressable with Trunking 2.2
   Market Expansion      3.0x

The results have begun to validate the KNG strategy…

High-Profile Wins, Growing Faster than Peers, Demonstrating Significant Operating Leverage
Around the time of RWC’s inclusion in the RKB (late 2011), RWC received their first substantial international military order with the Australian Defence Industries. Shortly thereafter, RWC received orders from several branches of the US military for trunked portable and mobile VHF/UHF radios. These military segments had not previously purchased RWC’s products. Meanwhile, RWC established relationships with FEMA, US Department of Commerce and the Veterans Administration.

In March of 2012, RWC had been named a supplier under the TacCom contract issued by the US Department of Homeland Security. Then, in May 2012, RWC announced that it teamed with ARINC as a supplier of P25 digital two-way radio equipment for deployment on a planned new emergency radio system to interoperate among Lancaster and Chester Counties in PA, and Maryland. They followed this win with RWC’s first order from Harris County, TX; the third largest county in the US. Harris County was looking for a viable second source and will be upgrading a substantial number of radios over the next few years.

Along with a slew of other wins, RWC’s sales grew by 114% in 2Q12 and another 16% in 3Q12. YTD (9 months), RWC’s sales have grown by 18.8% organically. In the same period, Motorola’s government sales grew less than 12% and Harris Corp’s RF Communications sales declined over 6%. Importantly, RWC’s base of revenue has diversified. 3Q12 saw solid growth without any large customer announcements.

This revenue growth has driven significant operating leverage. RWC implemented an expense reduction plan in 2011 resulting in a 14% overall reduction and they’ve kept a lid on opex since. With top line growth, RWC has seen its operating and EBITDA margins expand to historic highs. This little company has outpaced both MSI’s and HRS’ margins in the past couple of quarters with significantly lower average selling prices. We think RWC’s EBITDA breakeven is <$5m revenue per quarter. Let’s assume $5m/quarter ($20m p.a.) for arguments’ sake. In 3Q12, RWC generated $8.1m of sales and $1.7m of EBITDA. A simple analysis suggests that ~54% of sales drop to the bottom line above $5m. This is validated with an analysis of 2Q12 when RWC generated $9.3m of sales and $2.3m of EBITDA.

Extremely Cheap and Profitable; Significant Upside Potential

   Current assets $26.6
   Current liabilities 5.2
Working capital 21.4
   % Market Value      90.4%
   
   Current assets $26.6
   Total liabilities 5.3
Net/net analysis 21.3
   % Mkt. Val. 89.9%

With a $5m per quarter breakeven ($20m per annum), 90% of its market value in cash and working capital, and a 65 year history, we think the risk of permanent capital loss is low. 2008 is the only year in the past decade that RWC failed to generate at least $20m in sales, and even that year was $19.2m. Additionally, RWC generates a return on invested capital substantially in excess of its cost of capital despite trading below tangible book value.

Tangible Book                $29.8
P/TB 0.8x
WACC 8.6%
ROIC (TTM) 13.2%
EVA Spread 4.6%

The Company has generated $3.7m of FCF YTD (nine months to 9/30) and we expect they’ll generate $4.4m next year (2013) at a modest 5% sales-growth rate. This equates to an 18.7% FCF yield.

We think RWC is cheap simply because nobody's looking. Last time RWC achieved our 2013 sales/EBITDA targets (2006), the stock had a $100-$150m market cap vs. $23m today. The stock was sold down and forgotten during the credit crisis despite management's ability to navigate the difficult environment while continuing to spend on the future of the company (KNG family of products). Now the company has a larger market opportunity than ever before, has been growing significantly, and has an enterprise value near decade lows (exclusing the 1Q09 timeframe when the overall equity markets were decimated).

We think that a business at a positive inflection point, growing faster than its competitors, and expanding margins while serving a large industry with significant forward demand drivers armed with a fully refreshed product suite, should command a valuation closer to 10x FCF. At 10x our 2013 FCF estimate, our target price is $3.30, 87% higher than today’s. This remains a conservative valuation as $3.30 equates to only 12x our 2013 EPS estimate, well below the leader in the space.

Extended P25/CAP Backgrounder
LMR systems are the most widely-used and longest-used form of wireless dispatch communication in the US, having been first placed in service in 1921. Radio transmissions were initially transmitted in an analog format. Over time, advances in technology decreased the cost of LMR products and increased its popularity and usage by businesses and other agencies. To respond to growing usage, additional spectrum was allocated by the FCC.

As a result of the limited spectrum availability, the FCC mandated that new LMR equipment utilize technology that is more spectrum-efficient. This meant the industry had to migrate to digital technology. Responding the mandate, the Association of Public Safety Communications Officials (APCO), in concert with several LMR manufacturers, recommended a standard for digital LMR devices that would meet spectrum-efficiency requirements. The standard is called Project 25 (“P25”)

The primary objectives of P25 are to: 1) allow effective and reliable communication among users of compliant equipment, regardless of manufacturer (interoperability); 2) maximize radio spectrum efficiency; 3) promote competition among LMR providers through an open system architecture. P25 is effectively what allows RWC to compete for subscriber terminal business.

The P25 Compliance Assessment Program (CAP) is a voluntary program allowing LMR manufacturers to formally demonstrate their products’ compliance with P25 requirements. The purpose of the program is to provide federal, state and local emergency response agencies with evidence that the communications equipment they’re purchasing satisfies standards for performance, conformance, and interoperability.

To assist the emergency response community with selecting interoperable communications equipment, DHS provides the Responder Knowledge Base (RKB) website; an integrated, online source of information on products, standards, certifications, grants, and other equipment-related information. Manufacturers must submit a Supplier’s Declaration of Compliance and Summary Test Report to inclusion on the site. These documents provide a means of verifying that federal grant dollars are being invested in standardized solutions and equipment that promotes interoperability.

Risk Factors

  • Seasonality – 4Q/1Q are typically seasonally weak and are EBITDA neutral to slightly negative with the new expense structure in place.
  • Execution Risk – the new KNG radio family addresses a public safety customer base that historically has not purchased from RWC.
  • Switch from 25 kHz to 12.5 kHz band usage was mandated for some users last year. RWC’s management hasn’t outlined this as a substantial sales driver, Motorola mentioned it contributed only 3% to their growth, dozens of waivers in major markets have been issued by the FCC for up to four years in some instances, and most radios are still analog.
  • Poor visibility due to the lumpy nature of orders.
  • Illiquidity of the stock.

DISCLAIMER
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.

I do not hold a position of employment, directorship, or consultancy with the issuer.
Neither I nor others I advise hold a material investment in the issuer's securities.

Catalyst

  • Continued market traction with KNG product family
  • Ramp up of previously announced projects (ARINC, TacCom, etc.)
  • State and local customer win announcements (similar to the Maryland announcement last week)
  • Continued top-line performance
  • Margin expansion / cash flow generation
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    Description

    RELM Wireless is close to a net/net with meaningful growth and a high-teens FCF yield. The business is at an inflection point as its new product family addresses a substantially larger addressable market and its revenue base broadens. Despite a larger growth opportunity than ever before and significant organic revenue growth and margin expansion, RELM's current enterprise value is near historic lows.

    RELM Wireless:
    1. Serves a growing market with strong demand drivers
    2. Recently tripled its market opportunity with its new family of products
    3. Has been winning high profile customers, growing much faster than peers
    4. Is demonstrating significant operating leverage; more than 50% of the incremental dollar falls to the bottom line
    5. Has 90% of its market value in cash and net working capital
    6. Generates a 19% FCF yield (2013)

    The Company
    RELM Wireless ("RWC") makes two-way land mobile radio (LMR) products used for handheld (portable) and vehicle (mobile) communications. In addition to radios, its products include base stations (improve radio performance by enhancing signal, etc.), repeaters (expand range of mobile radios) and related subsystems. LMRs are commonly used by the public safety sector (e.g., police, fire, and emergency responders) and government agencies.

    The Company offers products under two brand names: BK Radio and RELM. Generally, BK Radio products serve the government and public safety market, the substantial majority of RWC’s revenue. BK Radio products are high-spec LMRs for professional radio users primarily in government and public safety. The BK Radio brand includes the next-generation KNG (“King”) product line which has significantly expanded RWC’s market opportunity.

    RWC offers radios with high-specification performance, durability and reliability at a low cost relative to comparable offerings.

    Insiders own 15% of the common stock.

    Growing Market with Strong Demand Drivers
    Market demand for RWC’s products is strong and being driven by technological innovations, government mandates, and an aging mission-critical infrastructure.

    Aging Public Safety Radio Infrastructure: There is a considerable movement to migrate from analog radios to digital. Of the 40 million professional and commercial radios worldwide, 10% or less are digital. A recent Barron’s article revealed that 44% of municipalities hiked expenditures on public safety despite tight local budgets. RWC’s products are comparable in quality, reliability, performance, and features at a substantially lower price than the competition. RWC’s average BK Radio package costs $1,350 vs. Harris’ average of $2,100 and Motorola’s average of $2,650; a 36% and 50% discount, respectively with no trade-off in quality, reliability, ease of use, battery life, etc. As such, we believe that aging infrastructure is a driver for the industry, while fiscal responsibility is a driver for RWC.

    DHS Tactical Communications: “TacCom” is a $3bn program released in March 2012 with a two-year base period and three one-year options through 2017. The purpose of this contract is to facilitate procurement of P25 land mobile radios (LMRs) while leveraging the buying power of the DHS and other agencies to foster a competitive, technology-neutral environment. RWC’s agents were successful in obtaining a “Small Business Set Aside” wherein small businesses are considered independent of large business proposals. This opens the door to a more level playing field through guidelines assuring that qualified small suppliers are the beneficiaries of a portion of the equipment procurements. Other agencies are able to procure under this vehicle including the White House Communications Agency, Department of Interior, Department of State, and Department of Justice.

    APCO P25: “P25” is a collaborative project to ensure that two-way radios are interoperable. Varying protocols and spectrum make it difficult for Public Safety responders to achieve communications interoperability. This was painfully evident during the disasters that the US faced over the last 10-15 years. For example, fourteen minutes after a hijacked airliner plowed into the World Trade Center’s North Tower on Sept. 11, 2001, the Port Authority Police Department radioed orders to evacuate the entire complex in lower Manhattan. That order wasn’t heard by the deputy fire safety director in the South Tower, whose radio operated on different frequencies. Three minutes later, a second airplane hit his tower. Although P25 has been around for decades, P25 adoption has accelerated only in recent years.

    Significant Increase in Addressable Market
    RWC has its roots in VHF (low frequency) selling to federal customers like the Department of Interior and the US Forest Service. Product cycles tend to last 7+ years and have been lengthening. Over the past several years, RWC has rolled out the KNG (“King”) family of richly featured P25 radios that address the majority of the federal, state, and local public safety markets. State and local public safety is a large opportunity.

    The introduction of their first UHF (higher frequency) KNG products in the ‘08/’09 timeframe and their first 800 MHz public safety radio allowed RWC to begin seeding the market with their portable product. During this time period, RWC also introduced their first KNG Mobile Radio on the VHF spectrum; UHF versions followed in 2011.

    RWC took the further step of developing their own trunking technology rather than relying on a third-party license as most competitors do. This drives margins and profitability ahead of the competition and keeps competitors out of their system.

    In June 2011, the KNG Series radios were validated under the P25 Compliance Assessment Program (CAP) as being interoperable with competitors’ communications network infrastructure. Having been validated on the infrastructure of four main providers, RWC’s KNG product line was included on the Responder Knowledge Base (“RKB”). The purpose of this was to provide federal, state and local emergency response agencies with evidence that the communications equipment they’re purchasing meets P25 standards for performance, conformance, and interoperability. For RWC’s sales efforts to be effective, this was an important step to help customers understand that the KNG products will work on their existing systems.

    The KNG line now boasts >100 SKUs and RWC has plenty of manufacturing capacity to ramp up volumes. With this feature-rich family of radios, in-house trunking technology, CAP certification on existing infrastructure, and the RKB stamp of approval in place, RWC successfully tripled their market opportunity by late 2011:

    Total & Addressable Markets $bn
       Global Market 9.0
       North American Market 5.0
       North American Terminal Market 2.4
       North American Conventional Terminal Market 1.0
       North American Trunking Terminal Market 1.4
       
       RWC Conventional Markets Addressable 0.7
    RWC Markets Addressable with Trunking 2.2
       Market Expansion      3.0x

    The results have begun to validate the KNG strategy…

    High-Profile Wins, Growing Faster than Peers, Demonstrating Significant Operating Leverage
    Around the time of RWC’s inclusion in the RKB (late 2011), RWC received their first substantial international military order with the Australian Defence Industries. Shortly thereafter, RWC received orders from several branches of the US military for trunked portable and mobile VHF/UHF radios. These military segments had not previously purchased RWC’s products. Meanwhile, RWC established relationships with FEMA, US Department of Commerce and the Veterans Administration.

    In March of 2012, RWC had been named a supplier under the TacCom contract issued by the US Department of Homeland Security. Then, in May 2012, RWC announced that it teamed with ARINC as a supplier of P25 digital two-way radio equipment for deployment on a planned new emergency radio system to interoperate among Lancaster and Chester Counties in PA, and Maryland. They followed this win with RWC’s first order from Harris County, TX; the third largest county in the US. Harris County was looking for a viable second source and will be upgrading a substantial number of radios over the next few years.

    Along with a slew of other wins, RWC’s sales grew by 114% in 2Q12 and another 16% in 3Q12. YTD (9 months), RWC’s sales have grown by 18.8% organically. In the same period, Motorola’s government sales grew less than 12% and Harris Corp’s RF Communications sales declined over 6%. Importantly, RWC’s base of revenue has diversified. 3Q12 saw solid growth without any large customer announcements.

    This revenue growth has driven significant operating leverage. RWC implemented an expense reduction plan in 2011 resulting in a 14% overall reduction and they’ve kept a lid on opex since. With top line growth, RWC has seen its operating and EBITDA margins expand to historic highs. This little company has outpaced both MSI’s and HRS’ margins in the past couple of quarters with significantly lower average selling prices. We think RWC’s EBITDA breakeven is <$5m revenue per quarter. Let’s assume $5m/quarter ($20m p.a.) for arguments’ sake. In 3Q12, RWC generated $8.1m of sales and $1.7m of EBITDA. A simple analysis suggests that ~54% of sales drop to the bottom line above $5m. This is validated with an analysis of 2Q12 when RWC generated $9.3m of sales and $2.3m of EBITDA.

    Extremely Cheap and Profitable; Significant Upside Potential

       Current assets $26.6
       Current liabilities 5.2
    Working capital 21.4
       % Market Value      90.4%
       
       Current assets $26.6
       Total liabilities 5.3
    Net/net analysis 21.3
       % Mkt. Val. 89.9%

    With a $5m per quarter breakeven ($20m per annum), 90% of its market value in cash and working capital, and a 65 year history, we think the risk of permanent capital loss is low. 2008 is the only year in the past decade that RWC failed to generate at least $20m in sales, and even that year was $19.2m. Additionally, RWC generates a return on invested capital substantially in excess of its cost of capital despite trading below tangible book value.

    Tangible Book                $29.8
    P/TB 0.8x
    WACC 8.6%
    ROIC (TTM) 13.2%
    EVA Spread 4.6%

    The Company has generated $3.7m of FCF YTD (nine months to 9/30) and we expect they’ll generate $4.4m next year (2013) at a modest 5% sales-growth rate. This equates to an 18.7% FCF yield.

    We think RWC is cheap simply because nobody's looking. Last time RWC achieved our 2013 sales/EBITDA targets (2006), the stock had a $100-$150m market cap vs. $23m today. The stock was sold down and forgotten during the credit crisis despite management's ability to navigate the difficult environment while continuing to spend on the future of the company (KNG family of products). Now the company has a larger market opportunity than ever before, has been growing significantly, and has an enterprise value near decade lows (exclusing the 1Q09 timeframe when the overall equity markets were decimated).

    We think that a business at a positive inflection point, growing faster than its competitors, and expanding margins while serving a large industry with significant forward demand drivers armed with a fully refreshed product suite, should command a valuation closer to 10x FCF. At 10x our 2013 FCF estimate, our target price is $3.30, 87% higher than today’s. This remains a conservative valuation as $3.30 equates to only 12x our 2013 EPS estimate, well below the leader in the space.

    Extended P25/CAP Backgrounder
    LMR systems are the most widely-used and longest-used form of wireless dispatch communication in the US, having been first placed in service in 1921. Radio transmissions were initially transmitted in an analog format. Over time, advances in technology decreased the cost of LMR products and increased its popularity and usage by businesses and other agencies. To respond to growing usage, additional spectrum was allocated by the FCC.

    As a result of the limited spectrum availability, the FCC mandated that new LMR equipment utilize technology that is more spectrum-efficient. This meant the industry had to migrate to digital technology. Responding the mandate, the Association of Public Safety Communications Officials (APCO), in concert with several LMR manufacturers, recommended a standard for digital LMR devices that would meet spectrum-efficiency requirements. The standard is called Project 25 (“P25”)

    The primary objectives of P25 are to: 1) allow effective and reliable communication among users of compliant equipment, regardless of manufacturer (interoperability); 2) maximize radio spectrum efficiency; 3) promote competition among LMR providers through an open system architecture. P25 is effectively what allows RWC to compete for subscriber terminal business.

    The P25 Compliance Assessment Program (CAP) is a voluntary program allowing LMR manufacturers to formally demonstrate their products’ compliance with P25 requirements. The purpose of the program is to provide federal, state and local emergency response agencies with evidence that the communications equipment they’re purchasing satisfies standards for performance, conformance, and interoperability.

    To assist the emergency response community with selecting interoperable communications equipment, DHS provides the Responder Knowledge Base (RKB) website; an integrated, online source of information on products, standards, certifications, grants, and other equipment-related information. Manufacturers must submit a Supplier’s Declaration of Compliance and Summary Test Report to inclusion on the site. These documents provide a means of verifying that federal grant dollars are being invested in standardized solutions and equipment that promotes interoperability.

    Risk Factors

    DISCLAIMER
    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.

    I do not hold a position of employment, directorship, or consultancy with the issuer.
    Neither I nor others I advise hold a material investment in the issuer's securities.

    Catalyst

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