Price History
Premium Content
Premium Content
Premium Content
Valuation – Audinate
In my earlier straws and posts this morning, I concluded that “the story” for Audinate was intact and made sense, but that I wanted to take a closer look at the numbers.
I’ve now done that work, and unfortunately, I can’t see how $AD8 gets on a trajectory to make enough money to justify its share price.
Accordingly, I exited this afternoon in RL and SM.
I’m not going to rehash the results or the outlook, as I think various StrawPeople have covered that well enough today. I will focus here on how I have translated today’s presentation and what management said into my assessment of value.
Having done this work, I’ve concluded that I don’t actually have any clue as to what the business is worth, However, the weight of analysis leads to numbers I don’t like. And because I could from $4.80 to $5.05 (in RL) and $4.785 on SM, that looked like a good deal to me, so I took it.
I'll go through the details of my analysis.
Methodology
I’ve generated a range of scenarios to generate NPAT and EPS out to FY32. By that time, earnings are growing strongly, so I’ve then applied P/Es of 30, 40 and 50, and discounted back to today.
I considered having a go at a DCF, however, it’s not clear enough what the economics are around investment, so I reverted to extrapolating the financials instead. When you look at the scatter of ranges I get in the graph at the bottom, it pretty much doesn’t matter what method you use. (I defy anyone to trial and nail valuation down more tightly!)
That in itself was reason enough for me to decide that I can’t own this business anymore.
The Big Drivera – What Changed?
Three things have happened, that lead to me not understanding the value of $AD8 anymore:
1. Revenue: FY25 revenues went backwards, materially. We’ve written a lot about this before (i.e., industry ”Bullwhip”) on this forum, so I won't repeat it.
2. Industry Outlook and $AD8 positioning: Coincident with the “bullwhip” is the realisation that FY22-24 had temporary tailwinds of end customers investing in Pro AV networks to support things like hybrid working. The outlook for the industry now isn’t fabulous (AVIXA 3.9% industry growth short term; other sources show 4%-5% medium term; $AD8 revenue growing at 2 to 3 times industry). that's not such an exciting prospect.
3. Three-legged strategy driving business complexity and cost: As @DrPete rightly pointed out earlier today, the three-legged strategy has made $AD8 a complex business. “Video” is not yet profitable, and “Control” is barely launched, with IRIS launching later in FY26. So, +25% Opex for FY26, at a time when Gross Margin is expected to grow at only 13%-15% compounds the harm done to the FY25 financials by the supply chain problems. And don’t forget the investment in acquiring IRIS is going to further elevate D&A.
The business complexity point is not to be down-played. Each product, whether hardware or software, will have a finite life cycle, a need to support customers on legacy platforms (Aidan made references to this today), so the product portfolio can be expected to proliferate over time. Yes, this will be easier to manage as software becomes a greater share of revenue, however, $AD8 is not a digital native, and they have not demonstrated that they have the capability of effectively and efficiently managing software lifecycles.
In my preparations for the FY25 results, I was expecting to tell a story about a business that has suffered a 1-year hit, resulting from a transitory supply chain disruption. Instead, I’m looking at a business where the combined effect of the existing supply chain disruption, together with the investment needs to stand up the next two legs of the business have pushed profitability out into the future by 3, 4 or 5 years – depending on what you believe.
So, to the numbers and the scenarios I considered in valuation.
Revenue
With revenue growth of 2-3 times the industry, I’ve considered annual revenue growth scenarios or 10%, 12% and 15%.
Gross Margin
Over the period FY26 to FY32, I’ve assumed % Gross Margins advance steadily from 81% to 88%, as more and more of the revenue’s come from software, and hardware becomes less important.
Opex
We’ve been guided to +25% Opex growth in FY26, to support the launch of the “Control” leg of the business.
I’ve assumed that Opex growth moderates in FY27 (+6-10% in the high growth scenario; +5-7% in medium growth scenario; and +4-6% in low growth scenario).
Thereafter from FY28 to FY32 I’ve assumed 4% and 5% Opex Growth depending on the scenario.
Non-Operating Income
Income from the current cash pile was important this year, and I’ve ramped this down over the next 4 years, as the cash pile is depleted and as interest rates ease a little further.
Capex
Because I’m running a financial model, the impact of capex isn’t explicit, as the D&A is embedded in the Opex growth assumption.
However, D&A as a % of revenue has averaged 16% over the last 7 years, with [PP&E+Intangibles] amounting to 23% of revenue.
So, one question is, once the three legs of the platform are built doesn’t investment slow down, and will this help drive operating leverage? I clearly assume it does, given the modest rate of Opex growth from FY28 onwards, but again, this is where the portfolio complexity can bite. All of the products in the market have a limited life cycle, and so $AD8 will need to innovate continuously, bringing new features to market across the portfolio.
Ideally, I’d have looked further at this. However, management have never really given a lot of insight into the R&D and Capex programme. So I felt that looking at this in further detail is meaningless.
Shares on Issue
I’ve made an allowance for 2% annual growth in SOI.
Other Parameters
Tax rate – no taxes paid while unprofitable, and I’ve assumed in the later years a tax rate of 15% is payable, as there will be a significant deferred tax asset.
Discount rate – 10% applied.
Scenarios
Table 1 (below) lists the 9 input scenarios that went into the valuation.
Output
Outputs for selected metrics are show in the table below.
Graphical Output
My p50% valuation ranges from about $2.00 to $3.80, depending on the FY32 P/E, with the range of scenarios generating valuations anything from about $1.00 to $7.50.
My Conclusions
It really should come as no surprise that it is virtually impossible to value $AD8 with any conviction. Afterall, in 2022 an unprofitable, hardware audio networking business pivoted to software, as well as entering the Video networking business via acquisition. Now, barely 3 years later, a barely profitable business suffers a material supply chain shock, while at the same time evolving the strategy to add on the “control” segment via an essentially pre-revenue acquisition.
I certainly don’t know what the economics of this business look like, and the valuations presented here are simply what I think might be a range of reasonable extrapolations of the recent financials, the guidance given, and the industry attractiveness.
For my valuation, I am going to settle at $3.00, and I’m going to put a range around that of $1.50 to $7.50.
From today’s share price of c. $5, I don’t like the potential downside of this investment, and the upside doesn’t look exciting enough for me. Afterall, even in the best scenario, we face another 4-5 years where this is a loss-making business.
Who knows what new challenge will arrive in the intervening period.
I’m out.
Disc: Not held in RL and SM
Disclaimer:
This is not investment advice. Scenarios are illustrations only. This analysis is only intended as a record of my personal decisions.
I really like @Slomo's characterisation of $AD8's competitive positioning in the audio, video, and Pro AV Software (i.e. control) market segments.
I believe that if $AD8 has stuck to pure audio it would a small, profitable business dominating its sector, but of course eyeing the growing importance of AV, and eventually seeing the growth of that segement limit the ultimate long term opportunity for a networked audio pureplay.
At the time of the Silex acquisition here, I wrote on this forum that $AD8 was going to face greater competitive intensity in video than audio. And with the annual competitive benchmarking in video now reported alongside audio, we are getting some quantification of that. However, as others as well as $AD8 have observed, video networking is at an earlier stage of market development, and it will be a larger market. So in that context, being a #2 or even a #3 can still be OK. It won't necessarily be a "winner takes" all. This is especially true as providers of protocols move away from CCM solutions to software, which should make it easier for manufacturers to produce hardware that can work with mutliple protocols. (Someone with more technical knowledge might want to correct me on that!)
OK, so now to the point of this post, which was also inspired given some of the research out earlier this week proposing that $AD8 is saturating audio, and that this will become a headwind.
On Monday, we are going to see the FY results, and so I have gone back over the last report and also over the last 7 years, reminding myself in detail of the $AD8 story.
Overall, this is a well-managed business from a resource allocation perspective, so I think the focus is really all about growth in Gross Margin. That's the number I'll be focused on.
But given the "bullwhip" (?) shock of 1H, I've decided to have a look at what I think the range around revenue for 2H and FY might be. To do this I have generated two scenarios for revenue: "slow recovery" and "fast recovery".
"Slow Recovery"
In this first scenario, I take management at their word. At 1H they basically said that FY25 would be a "one-year transition period, with customer returning to regular ordering patterns during FY26". They also said "Gross Proft in Q2 FY25 exceeded Q1 FY25 and we expect a moderate strengthening in the second half". Bear in mind that they were near the end of Feb when they've said his, so presumably they already had some isights into 3Q!
So, Figure 1 is my "Slow Recovery" scenario. I've used the word "slow" recovery, because in my "bullwhip" model, I've assumed that over the period of the supply chain disturbance, the revenue above the dotted line is offset by a period of muted customer buying below the dotted line. The scenario is "slow" because is takes a full 12 months for the customers' excess inventory to be worked through.
Note: These numbers are plotted by eyeball only, as of course we can never really know what's going on with any precision. But basically in the scenario shown, revenue growth gets back onto the long term trend of the black dotted line during FY26.
Figure 1: Slow Recovery
"Fast Recovery"
In the second scenario, the underlying customer growth is slightly steeper (dotted black line), and thus there was less "overbuying" to begin with and this excess inventory is worked through faster. In this scenario, we'll be back on the long term market growth trend by 1H FY26. And accordingly, there is a stronger recovery towards this in 2H FY25.
Again, I want to empahsise that these are just rough scenarios that consider what is an unknown underlying market growth and, therefore, high uncertainty into what the under/over-buying dynamics really were. As outsiders, I don't think we can ever know with more precision. Maybe that's even true for $AD8 management.
Figure 2: Rapid Recovery
FY25 Revenue Forecasts
So, now I can compare the result for the FY25 "forecasts" and also compare then with market consensus.
The current market consensus for FY25 Revenue for $AD8 is A$62.63m (www.marketscreener,com; n= 9), which at a fx rate of 0.65 is US$40.7m. So how does compare with my two scenarios?
Slow Recovery = US$41.9m
Fast Recovery = US$46.5m
Could revenue be less than my "Slow Recovery" forecast? Of course, My H2 / H1 is US$23.0 / US$18.9m, and I chose that step-up because I felt it was consistent with management saying that Q2 was ahead of Q1, which indicated that the recovery was starting. If the dominant factor driving revenue is the "bullwhip" effect and the recovery from it, then the recovery should accelerated into H2.
$AD8 customers will have adopted a range of behaviours in an industry where the inventory replenishment cycle is typically around 6 months. The post-pandemic policy of "insurance" buying likely pushed this out to 12 months or maybe more. But of course each customer will have had their own policy - so there will have been a distribution of behaviours, and reversion to the "new normal".
My main point is that if the return to normality started in Q2, this means that Q1 was the low point of the bullwhip effect and, even allowing for a range of customer behaviours, you'd expect reversion to the "new normal" within 12 months. In fact, I expect that reversion to be significantly faster, which is why I created the "Fast Recovery" scenario language.
Could revenue be greater than my "Fast Recovery" scenario? Arguably yes. Reversion to "new normal" inventory policies could drive a "slowly at first and then all at once" recovery dynamic. It would not be without precedent to see a strong acceleration from Q2 to Q3 and on to Q4. And then, don't forget that $AD8 have launched several new products in FY25, although the overall market demand in Pro AV has not been particularly strong in Fy25.
So there is complication on complication. For example, start of this data series is still impacted by lockdowns, so it is probably completely flawed to try and establish a trend during 2021 and 2022, and of course in 2022 $AD8 added the video segment. All good reasons to not get too caught up in the details or worry about decimal points!!
Conclusions
Overall, I'm more bullish than the market consensus and expect $AD8 FY revenue to fall in the range US$ 42 - 47m.
I think anything in that range can be explained solely by the supply chain dynamics playing out.
If the revenue comes in significantly below $42m, then I would consider that other factors are at play. For example:
- Maybe we are seeing market saturation in audio (1 point to the bear thesis)
- Maybe there was faster customer conversion to software from CCM. In that case we will see relatively high software, higher %GM and overall a good Gross Margin number.
- Others ... ??
So, I'll be listening very carefully to what management say about the FY25 "year of transition" and equally to what they might be saying about customer behaviour in response to tariffs, the progress of new products, and pricing.
I'm not sharing this analysis because I think I can predict the outcomes. But I just find it help to get my head around this key uncertainty ahead of the company results, so that I have a frame of reference against which to assess what management say.
"See you" online on Monday morning!
Disc: Held in RL and SM
Today, I reluctantly exited my full position in $AD8 (IRL and SM). I sold off one-third ahead of results at $10.08 and the balance today around $8.50, a weighted price of $9. I’ve held this since mid-2018 … another Matt Joass MF Pro recommendation. So, it done OK, although not what I’d hoped for.
Why did I exit today? This Straw is my investment decision diary entry. I make a number of assertions and assumptions about audio, video and software enablement. I’m not an expert in these areas. Having watched the investment thesis unfold over 4 years, in the absence of support from favourable economics, I am uncomfortable holding a sizeable position going forward. That said, should SP fall significantly below my target price, I’d consider buying again.
What was the initial thesis? As shown in the figure below, which is faithfully updated each year, $AD8 has world-leading tech in audio networking. (Note: I’ve written audio and not broader digital media.) Sure enough, ever since following AD8, whenever I am at a conference venue or a lecture theatre (part time day job), you find evidence of “Audinate Inside”. It is truly dominant in digital networking of audio equipment.
Tracking the evolution of cashflows since 2016, it appeared that operating leverage (dashed grey line) was developing, albeit slowly.
Then four things happened:
1. COVID19 – driving a market slow down in the use of venues using networked audio equipment
2. CVOID19 Part 2 – supply chain constraints, chip constraints, inflation
3. Acquisition of Video capability (Cambridge, UK and Belgium)
4. Shift in focus from hardware to hardware and software; audio to media and cloud-enablement
Now 1 & 2 are simply a temporary set-back, 3. is an adjacency with a logic that has been articulated clearly by management and 4. Is logical, being a strategy followed in many other industries.
So as a narrative that’s all good. I’m onboard. But investing needs more than a narrative.
A few things dawned on me during the presentation yesterday. Aidan and Rob explained that the large step up in staff costs/headcount over the last year is driven in part by the acquired workforce and getting the bench in place to double the business over the next three years. However, as part of this discussion, it was clear that more staff would be required albeit a slower rate of growth. However, no indications were provided as to the likely trajectory.
Second, strategically, $AD8 has stepped from a niche where it has clear industry leadership (digital audio networking) to a more contested space: video, video-networking and software enablement via cloud-solutions.
My concern is that this broadening of the development front is going to bring with it increased costs. While Aidan and Rob and the team are experts in audio, I don’t think they can claim to be so in video, and the acquired teams from Cambridge and Belgium – while having unique IP – also don’t have experience in scaling their technology across global markets. (We have seen just in the last year how at $AMS, slight changes in go-to-market approach can quickly have dramatic, adverse impacts on sales growth.)
In short, I am uncomfortable seeing this widening of focus, particularly when we haven't even been able to see if the current business model can scale. That's a big red flag.
So, I did some what-if analysis around cost and investment uncertainty, around reasonable growth scenarios. The base case is set out in today's Valuation Report, and yields a valuation of $8.50, which by coincidence is in the ball park of today's price.
(Note: the broker consensus (yet to be fully updated) is about $10.50.But the more I read, the more I wonder if they are cuaght up in the story, driven off revenue growth and not analysing the economics. We shall see.)
Bear Case:
In this case, revenue growth slows sooner, because the combined audio and video and cloud solutions are playing into a more contested space, and costs scale less favourably. I ended up with a valuation of c. $4.50. But you could get anything from $2.50 upwards. What was instructive, was that it didn’t take much to seriously impair the economics. This kind of scenario would result if, in years 1 to 3, they incur higher development costs, then followed by increased competition in the market due to others contesting the space leading to an earlier maturing. There is, after all, little evidence they can replicate their dominance in networked audio to networked media. I’m not saying the can’t or won’t. They might well be successful. I just don’t have any basis of confidence so that’s my bear case.
Bull Case:
In this case, 30% revenue growth is sustained for a further three years beyond 2025, with favourable economics for operations and investment, with the business maturing but still growing by 2029. This yields a value/share of c. $11.50. Again, you can easily get anything from $11-14 depending on your assumptions.
My Conclusion:
Going for video, software and hardware and cloud-enablement on the back of a major industry setback and ongoing headwinds in chip supply and staff costs has muddied the waters around what I had expected would be solid emergent operating economics by this time. There are too many uncertainties and I don’t know enough about the industry or the competition. On balance, I feel scenarios towards the bear case are more likely than the bull.
I am selling. (Have now sold.) I like this company and the management, and I am going to continue to follow them. I am confident that I will be presented with future opportunities to get back onboard well below $8.50, should evidence indicate that we are more towards the Bull Case. At this early stage in its life - absent compelling economics - history tells me that the SP will be volatile.
(Note: This is not investment advice. It is a record of my own decision process.)
Disc: Not held IRL and SM