FWIW Morningstar has recently initiated coverage of Audinate at a four star (undervalued) rating with their fair value estimate of $23
Analyst Note | by Roy Van Keulen
We initiate coverage on Audinate with a fair value estimate of AUD 23 per share. We assign Audinate a narrow economic moat based on network effects. We forecast revenue to grow at a 10-year CAGR of 22% and EBIT margins to expand to 36% by fiscal 2033 from 1% in fiscal 2023. We use a weighted cost of capital of 9%. We assign Audinate a Morningstar Uncertainty Rating of High and rate its Capital Allocation as Exemplary. At current prices, Audinate shares screen as materially undervalued and not reflective of our view of Audinate as a well-managed high-quality company with a large and highly winnable market opportunity
Audinate’s Dante protocol has become the world’s most widely used protocol for audio networking. Today, there are over 4,000 products available which are enabled with its protocol, which is more than 10x its nearest competitor. Audio networking protocols allow professionals in the AV industry to connect, control, and manage their audio systems with minimal friction. Network effects arise from strong interoperability within networking protocols, and limited interoperability between them. In other words, products using the same protocol work well together, while products on different protocols experience more friction. AV professionals therefore prefer using products which are on the same protocol and prefer using protocols with a large catalogue of available products and widespread adoption. Given Dante’s extensive lead over its competition, we see AV professionals gravitating towards the Dante protocol. OEMs, in turn, prefer building products which are in demand by AV professionals, thereby creating a network effect. Because of these network effects, we consider the audio networking market as highly winnable
Business Strategy and Outlook
We expect Audinate’s strategy to primarily focus on accelerating the secular transition toward digital audio networking. Secondarily, we expect Audinate to focus on building out its nascent business for digital video networking
Audinate’s Dante protocol has become the world’s most widely used protocol for digital audio networking and boasts a more-than 10 times lead over its nearest competitor, Ravenna, in terms of the number of products enabled with the protocol. Given Dante’s dominant market share, we see little remaining upside for Audinate from gaining incremental market share from direct competitors in digital audio networking. However, we do expect Audinate to use its network effect, its existing customer relationships, and its scale on research and development to accelerate the AV industry’s transition toward digital audio networking. Specifically, we expect Audinate to continue creating new hardware solutions and reference designs that unlock new device use cases and to continue developing new software solutions for AV professionals. We estimate Audinate has around 10% market share in audio devices, which leaves Audinate with a large and highly winnable market opportunity, as the industry digitizes. Additionally, we expect Audinate to gain significant pricing power, especially in its software segment, as its network effects continue to strengthen
We also expect Audinate to continue developing its nascent digital video networking business, although we view this as a more uncertain and likely less profitable opportunity. Video networking has unique challenges compared with audio, primarily due to the larger data intensity inherent in video data delivery. Because of this, digitally networked video uses various compression technologies that are usually not compatible with each other and therefore hinders the establishment of network effects. However, we believe network effects from Dante’s audio solutions will help pull in AV professionals, who are already familiar with the Dante protocol, which in turn pulls in original equipment manufacturers, or OEMs
Economic Moat
We assign Audinate a narrow economic moat based on network effects in its digital audio networking protocol, Dante. We expect Dante to become the standard for digital audio networking, and for digital to continue to take share from analog networking
Dante is the world’s most widely used protocol for digital audio networking. Over 400 OEMs, such as Bosch, Bose, and Yamaha, license the Dante protocol to enable digital delivery and management of audio for over 4,000 products, such as microphones, mixers, and speakers. Dante’s closest competitor, Ravenna, has fewer than 400 products enabled with its own protocol, and works with fewer than 100 OEMs
Network effects arise from strong interoperability within networking protocols, and limited interoperability between them. When audio products are enabled with Dante, these products can be easily discovered by- and connected to the Dante- network and other Dante-enabled products on the network, which is required for their audio delivery to be synchronized. Such automated discovery and connection provides a compelling benefit for AV professionals because it allows them to easily add, move or remove audio equipment to their installations. This benefit may even exceed any perceived brand value toward specific OEMs. Products not enabled with Dante can still be added to the network through AES67, which is an industry standard for audio over IP, but the networking process is more cumbersome. Similarly, competing networks can add Dante-enabled products through a more cumbersome networking process. Given the limited interoperability between the various networking protocols, Dante’s leadership position of more-than 10 times in terms of the number of enabled products results in clear demand pull from AV professionals
OEMs, in turn, need to cater to the preferences of AV professionals and are therefore increasingly choosing to enable their products with Dante, which leads to Dante’s leadership position expanding over time and a positive flywheel between supply and demand. Dante today enjoys a more than 10 times lead over Ravenna, in terms of enabled products, which is a significant improvement from a 6 times lead in 2017. We also expect Dante’s leadership in terms of deployed products to be even larger than its leadership position in available products, due to Dante’s larger network of interoperable products making its products more appealing to AV professionals
We view analog networking as Audinate’s primary competition. In analog networking, AV professionals connect products by drawing physical cables between them. This cabling is usually many times pricier than digital networking because the cables need to be drawn the full distance between devices. By contrast, the Ethernet cables used to connect Dante-enabled devices can typically be drawn to the nearest Ethernet port in a building. Many devices also don’t require separate power cabling after they are connected with an Ethernet cable. This provides material savings in terms of hardware and labor costs. Additionally, over longer distances, analog audio cabling can suffer from reduced audio quality, which digital audio delivery does not suffer from. Unsurprisingly, the industry has been rapidly digitizing. We estimate that digitally enabled audio devices doubled their market share as a share of new sales to around 10% in 2023, from 5% in 2016. Analog networking continues to be the dominant networking technology, primarily due to switching costs from existing installations and digital networking being cost prohibitive for lower-value devices and use cases
We don’t yet see similar network effects in Audinate’s video networking business. Video networking has unique challenges compared with audio, primarily due to the larger data intensity inherent in video delivery. Because of this, digitally networked video uses various compression technologies that balance speed, cost, data, and quality for specific use cases. As a result, products using different technologies are often not compatible, not just in their discovery and connection, but also in their data delivery. The industry is therefore still much earlier in its digital transition
We do believe Audinate enjoys several distinct advantages in pursuing video networking. Audinate has existing relationships with hundreds of OEMs, many of which also make video products. We believe offering bundling deals through these established customer relationships has traces of an intangible moat. A subset of AV products also has networking needs for both audio and video, which makes them an attractive market entry point for Audinate. Also, over the years, Audinate has been training hundreds of thousands of AV professionals on its technology. These professionals already know how to work with Dante-enabled products and are familiar with the brand, which, we believe, makes for an appealing proposition for OEMs. So far, Audinate is demonstrating strong momentum on all relevant metrics for its video networking business. These include growth in the number of OEMs licensing the protocol, the number of products enabled with the protocol, and in the number of products shipped with the protocol. However, this is from a small base, and we consider the market still up for grabs
Fair Value and Profit Drivers
Our fair value estimate for Audinate is AUD 23 per share, implying an enterprise value/sales multiple of 21 on our fiscal 2024 estimates. We use a weighted average cost of capital, or WACC, of 9%, reflecting high revenue cyclicality, medium operating leverage and low credit risk
We assume revenue to grow at an organic CAGR of 22% over the next decade, driven primarily by Audinate expanding the market for digital audio networking. We expect EBIT margins to expand to 36% by fiscal 2033, compared with 1% in 2023. We expect Audinate’s operating margins to expand because of sales and marketing spending, as well as research and development declining as a share of revenue, once its network effects strengthen. We also expect gross margin expansion as strengthening network effects result in increased pricing power
Risk and Uncertainty
We assign Audinate a Morningstar Uncertainty Rating of High
The AV industry is still in the early stages of digitizing, which means there is still high uncertainty regarding the ultimate market opportunity for Audinate’s products. Given that we view competitive risk as low in digital networking for audio, due to Audinate’s economic moat based on network effects, our uncertainty revolves around the market’s ultimate size, rather than Audinate’s share within this market. Within video, we see additional uncertainty around Audinate’s ability to take market share.
We see high risk from economic cyclicality. Audinate’s devices or license designs are used in products which are highly discretionary. Although these products are often part of systems which eventually need to be replaced, customers can choose to defer these purchases in challenging economic times
We see high risk from technological disruption. Audinate’s Dante protocol primarily uses Ethernet cables for data delivery. We cannot rule out other methods of data delivery eventually substituting Ethernet cables, such as wireless internet or other technologies
Capital Allocation
Audinate has an Exemplary Capital Allocation rating, reflecting our assessment of a sound balance sheet, exceptional investment efficacy, and appropriate shareholder distributions
Audinate’s balance sheet is sound. As of the end of December 2023, it held significant cash with no debt
We rate investment efficacy as exceptional. Although Audinate is supported by network effects, when it started, it faced the traditional cold-start problem, whereby no AV professionals wanted to use Dante’s protocol because there were no products supporting it and no OEMs wanted to develop products because no AV professionals wanted to use them
Audinate demonstrated exceptional execution to solve this problem. Audinate found the right entry points into the market, strategically attracted early customers by making them part owners of the business, developed a product portfolio with the right breadth and depth and delivered the right levels of customer service. All of these competing objectives were achieved with limited resources, which demonstrates to us exceptional capital allocation skills
Audinate does not currently return capital to shareholders, which we view as appropriate given the opportunities for investment into the business
DISC: Held in RL & SM
