In one write up (https://au.investing.com/news/analyst-ratings/jefferies-downgrades-audinate-group-stock-rating-to-hold-on-market-saturation-concerns-93CH-3970194) it was said that:

The downgrade comes as industry experts suggest that networked audio, Audinate’s core technology, has now saturated the majority of the company’s addressable market, potentially limiting future growth opportunities.

These industry experts might have a different view of Dante’s TAM but the company has Revenue of < $100m and last I checked said they were at < 10>

Valuation challenges

Audinate is not easy to value and the recent turbulence in their financials has made it harder as it’s near impossible to know what a sustainable growth rate might be, much less what margins or normalised earnings will look like.

But there’s a few things we do know with some degree of reliability.

Unfortunately these require some faith in management which has been severely dented in recent years.

That said, Management is relatively young / inexperienced in ASX years and hopefully will be learning fast from recent events.

And for all their missteps they have navigated some challenges well (mainly Covid disruptions to demand, then supply) and built an impressive product suite that dominates a niche (Audio over IP).

TAM

I always cringe a little when I try to use Total Addressable Market (TAM) to construct a valuation, however in this case it’s more instructive because of their competitive positioning and the uncertainty around future revenue growth and margins.

TAM is also just one perspective, and needs other inputs for context.

At the FY23 results, management updated their estimate of TAM for 3 segments – Audio, Video and Software & Services.

This more than doubled from the original cut taken prior to IPO in mid 2017 for a few reasons. They had more complete data ion FY23 which led to a higher number, growth in their market(s) over time and expansion of products leading to a larger accessible market size.

A continuation of these 3 factors are likely to lead to TAM increasing further over time.

CEO Aidan also said in one of the meetings (FY23 call or AGM) that they only include parts of the market that they can realistically take. So this might be thought of as SAM (Serviceable Addressable Market) – not sure if this terminology is still in use but it used to be get wheeled out in the heady days of TAM multiples to show the part of the TAM that was actually achievable. TAM is the entire pie, and SAM is a slice of that pie that the company can realistically aim for.

TAM was estimated at FY23 (in AUD at $0.65) for Audio as $510m, Video is $1.2bn and S&S is 1.4bn.

I’m going to start by basing my Valuation on Audio and treat the rest as (enormous) potential upside.

Audio Only

With about 10% share of the Audio Market and 14x the nearest competitor, they appear to have won this market and will grow it out over time. The move towards more software only installs should expedite (and probably further expand) this. Other factors that will expand this Audio TAM are product expansion (build or buy), a shift to software only installs and industry growth (5% CAGR does not seem overly aggressive).

So the question for me is how much of this market will they take, by when and with what bottom line margin? Management have said a couple of times that they expect a continued steady take up in audio (not a ’hockey stick’).

70% within 10 years would require a CAGR of 23% which seems high but not impossible for the dominant protocol in an industry that is quickly digitising. There’s a product lifecycle of up to 8 years in Pro Audio gear so they need to be picking up design wins fast to capture another 60% of the market within 10 years. This growth would be supported by Software Dev encouraging OEM’s to take on Dante to access their control suite (Dante Director, etc).

Bottom line margins of 15-20% at maturity in 10 years for a mostly software install does not seem unreasonable to me. If this eventuates, the Audio Part of the market would see earnings of $62m at the midpoint. A future PE of 8x based on today’s market Cap (21x PE when compounded / discounted at 10% RRR) just from Audio with no growth in TAM assumed over 10 years.

Beyond Audio

The Video and Software TAM’s are much bigger but more contested. NDI being the biggest challenge here. That said, the Video market is estimated to be a decade or more behind audio in its digitisation journey so there should be runway for both NDI and Dante to grow without needing to take share from each other.

Winning in Audio will help Video and Video will help Software (Control). Software Dev will also help Video as higher utility from OEM’s embedding Dante Video in their product for interoperability and control (OEM’s should be able to sell more Dante enabled kit).

Big Picture

If Dante can take 35% market share in Video and Software in 10 years (half that estimated for Audio) and at half the margins of audio, this will amount to about $140m Earnings. A future PE of 3.5x based on today’s market Cap (9x PE when compounded / discounted at 10% RRR) with more growth available and no growth in TAM assumed over 10 years.

Limbering up for Thursday’s beer and a whinge session at the Sydney Strawman drinks with a coffee and a whinge here…

I can’t believe the AD8 price, seems way too cheap to me.

At $6 per share, Market Cap is ~$500m.

Whether this is value or not really depends on your outlook for the business, and what this means for revenue growth and future margins.

The recent downgrades suggest that AD8 will no longer profitable in FY25, not even at the EBITDA level.

It’s helpful to reassess the investment thesis here and to compare that to recent performance.

This pretty quickly turns my disbelief at the stock price into an understandable reaction from a market that is mainly playing a different game to me. Shorters for example, have been increasingly active in this one. They are necessarily short term and fast moving while I plan to be the exact opposite.

Today the price dropped 10% at one point on no news but a quick AI search revealed a broker downgrade (Jefferies) from Buy w PT $9.50 to Hold w PT $7.50. They don't need to see the results next week to know what investors should do with their AD8 shares!

If I assume this downgrade is the driver of today’s move, this Price target is 25% above the current price of about $6.

A 25% return in 12 months (typical PT timeline) would be more than 2x the LT market average return, so surely a Buy rather than the Hold recommendation given and the Sell action taken?

Makes no sense to me, but why would it?

If I am playing tennis while most people are playing basketball it shouldn’t make sense unless I understand why they are making all that noise and their balls are too big (ahem…)

So why do I care about daily stock price moves at all?

I’m not trading on a day to day basis and I’m not looking to buy or sell AD8 as I’m fully stocked (at a higher average price).

I’d prefer not to look at the daily price moves but the market is where I do my shopping and I’m trying to buy when cheap and sell when expensive so it pays to know what the market is saying with it’s price signals.

There’s probably a darker side though – I am (at least subconsciously) also looking for signals amongst the noise and probably looking for some action / entertainment while I attempt to execute on Charlie Munger's 'Sit-On-Your-Ass' strategy.

It’s just about impossible (for me at least) not to look at daily price movements as it goes against our adaptive wiring to stay away from the noise and not pay attention to distractions (this used to save us on the threat rich savannah of our evolutionary past but can now financially wound us in the stock market jungle).

The only way for me to put the noisy price action in it's place is to keep anchored to an investment thesis that is anchored to a valuation that’s independent of market price.

So when the noise level rises, that's my cue to do some quiet reading and research...

Whinge over (for now).

Disc: Held