Audinate have announced that they’ve hired a Chief Strategy Officer to oversee M&A among other strategic growth initiatives.

This seems like a good position to fill given their M&A ambitions and the size of their war chest. It should also take some pressure off the incoming CFO whenever they get started. Also good to see a build out of Execs below the CEO as the business starts to mature, hopefully reducing some of the key person risk in the CEO, especially as their impressive, long standing CFO is departing soon.

Nick Pearce looks like a good fit based on his Linked In profile - https://www.linkedin.com/in/nick-peace-5a4ba64/details/experience/.

Having previously been an Audinate Board member and early investor for 4 years until about a decade ago, he’s clearly a believer in the business and a known quantity.

His prior role at Promedicus as Chief Strategy Officer for 2 years will be useful experience and with names like Starfish and Oracle on his CV it’s great to see Audinate can attract someone of this calibre.

To release a downgrade on the worst trading day / highest volatility since Covid shows the same mgmt. naivety as selling down into a Cap Raise.

This is potentially a downside of having a technical founder CEO rather than a professional / slick management. I would still take the owner operator (missionary) over ‘professional’ (mercenary) approach any day.

Other factors like the large cap raise at $13, still unutilised, CFO resignation, Directors selling above $20, relatively low insider ownership, would have put Audinate on a negative watch.

Broker reports saying that they are effectively a hardware maker (not true) and the vast bulk of their sales are non-recurring (not true) and 1 year price targets are closer to $13 would have helped prime the doors for a stampede.

This downgrade to guidance for FY25 was significant but also given the brevity of the release likely raises concerns about some of these prior actions – especially CFO resignation, director selling, raising at $13, etc.

The jaded trader set and the ‘I told you so’ brigade are negative on this stock and currently sounding smart and wisely cautious. They are playing a much shorter timeframe game to me but will likely be the marginal buyers / sellers / shorters so could push the price around quite a lot in the short term. 2.5% shorted last time I checked.

So I would be surprised if the share price rebounded any time soon in any meaningful way but that’s just my best guess.

Buffett talks about wanting to buy a great business with short term problems – his ideal situation is when they are on the operating table. That’s what this feels like to me but only time will tell.

Sharing my AD8 notes to myself following the recent downgrade, so apologies if some of this is repetitive has been covered elsewhere...

Growth

I think about Audinate’s growth as having 3 sources. All are from selling their Dante protocol in different forms. Note, this is different to the 3 segments they call out in their presentations – more on them below.

The primary revenue source is from sales to existing Original Equipment Manufacturers (OEM’s) who buy Dante enabled Chips, Cards & Modules (CCM’s) from Audinate.

The growth drivers I see are:

1)   Existing Dante enabled pro AV units being shipped in greater quantities over time. Note, this piece can also go in reverse, as is now forecast for FY25, but unlikely to drop for long as new products gain in popularity or are replaced by Dante enabled products that do and the market continues to grow.

2)   Design Wins in one year becoming sales in the next and subsequent years. This is likely the biggest driver of revenue growth and market penetration early on (especially for Video but more on that later).

3)   Software sales (SaaS) to end users, usually sound engineers, their employers or owners of networked installations (eg, Sydney Trains). The greater the ‘installed base’ from 1 & 2 above the higher the value proposition from Dante software to manage them. In time they’ll likely also / instead sell the protocol to OEM’s as software (licence per unit) rather than embedded in chips / hardware.

When an OEM designs a Dante chip into their hardware in Year 0 (aka a Design Win), sales of Dante CCM’s are triggered whenever new hardware is built. For Example, if a Pro audio equipment maker in South Korea makes 1,000 units of a Dante enabled product in Year 1 and ships 950 of these to distributors in US, Europe & Asia, 1,000 Dante enabled chips will be sent from Malaysia to South Korea, along with nuts and bolts from China, circuitry from wherever… to be assembled in South Korea. If these sell well, they might make 1,500 units in Year 2, so 1,500 Dante chips are sold for this product in this next year.

It seems existing sales in FY24 were brought forward to such a large extent by covid supply shocks that OEM’s have over stocked and won’t need to buy as many chips in FY25. Further this decline is unlikely to be made up for in new design wins (from FY24) or expected software sales in FY25.

The over earning in FY24 was a one off, FY25 should see lower Revenue AND Gross Profit, despite rising gross margin, so normalised revenue growth rates are probably something like the 22% average you get when you average the 6 years to FY25, including an estimate of -5% for next year.

3 Segments

Audinate split their market into Audio, Video & Software.

Audio is where they dominate with 12x the units in market of their nearest competitor. So even though they have less than 10% of the addressable market, they have 90% of the penetrated market and an even higher proportion of new units coming to market.

So there is 90% of the market still to be taken from the incumbent which is physical cabling of networked pro-Audio products.

Audinate’s dominance of this market suggests that Dante becoming the default Audio over Internet Protocol format is just a matter of time and management have said as much.

The key questions are how much of this 90% can they take, by when and what margins can they earn?

Video is the newest part of the strategy, the biggest focus for the business, the biggest opportunity, and the biggest risk.

This is off to a good start exceeding management expectations for units shipped and growing fast off a small base.

It probably needs some M&A to step up and compete against some of the larger competitors in this space. The $70m Cap Raise @ $13 in Oct-23 was to be used for this purpose but is still sitting on the balance sheet. More on that later.

Software is already a significant and growing piece of the Revenue mix (20% I think) and should grow well from here – just how far it can go will depend on the success of the Video strategy – at which point they can unify both formats under Dante as the Operating System for the Pro-AV Industry which is their stated longer term strategic aim.

I think of this as Audio being the foundation, funding source and playbook for Video penetration – this will be the battleground for dominance.

Video is the big opportunity as it potentially unites the industry under one format for Networking over IP and opens up the opportunity for high margin sticky software to manage a large installed base.

Valuation - Statistically Expensive (@ 14x Price to Sales), hard to value and only marginally profitable due to high reinvestment / Spending all their FCF on growth.

Strategy - Video a more fragmented (by protocol and participant) than Audio was.

Niche - Limited market with unlikely / uncertain growth opportunities beyond it.

Cash burning tech - Haven’t monetised it yet, so not sure how it will look when mature - need to guestimate future margins.

Gross Margin falling - This is primarily due to product mix as Viper board (video hardware from Silex acquisition) sales grow. Should be temporary?

License Fee based - more 'reoccurring' than recurring revenue. Will likely stay that way until Software & Services picks up, in the distant future.

Mgmt not buying at recent prices. CEO actually sold into (ahead of) the recent capital raise.

50% Revenue Growth - Great but ... hard to maintain.

M&A brings execution risk – implementations are not easy – especially when tech is at the centre of it.

Key person risk in Aidan CEO.

Something from left field - an Apple or a Google makes a competing protocol via an app to displace Dante?

What have I missed??

Disc: Held (largest position)

Key take always from the AD8 AGM for me (apart from TAM expansion per separate straw) were:

There are 2 main strategies

1) “Winning in video”, this will include M&A ($1.2bn Rev Video Mkt), this is their #1 priority.

2) “Building out the operating system of AV” ($1.4bn Rev Software & Services Mkt), this is the big Long Term prize.

So they have a long runway of reinvestment opportunities at (a high expected ROI).

Technically there's a 3rd strategy which is to dominate Audio, but I'd say this is just a matter of time and the focus of CEO Aidan's discussion is all around video. Software & Service (operating system for AV flows from that).

Execution on the Video strategy is everything, and I would say if they don't manage this, the thesis that supports the current share price is badly damaged.

If they can do in Video what they have done in Audio to dominate the Video market, S&S should be easier as they will be the de facto AV operating system and be able to build a product suite earning high margin SaaS Revenue on top of this.

The recent $70m Cap raise was to expedite their Video investment via M&A and in-house Dev (Capex), so aligned to this Video focus.

Expecting minimal growth in Opex so should start to see Operating Leverage in evidence in the next few years.

This Video strategy is de-risked in a few ways.

1) They are following the same playbook as they did in audio where they have now effectively won. Their Dante protocol has 9% of the available market (but 12x the penetration of their nearest competitor). Trajectory is also positive, as this was 6x a few years ago and will soon be > 12x as more design wins translate into OEM (product) deployments.

2) They have a very good name and relationships in the AV industry from their work in Audio. There are a lot of synergies for AV Engineers and OEM’s to have a single integrated protocol across Audio and Video combined – as they have won in Audio they can be the only integrated protocol across both.

3) The Video market is more fragmented than Audio with no clear competitor and the incumbent is inertia (See separate straw on NDI).

4) They have integrated 2 small acquisitions that have allowed them a rapid entry into the market increasing their products from 7 to 48 in FY23. It took more like 6 or 7 years to grow this part of the Audio build out.

Note: The above is not what they spelled out specifically in their presentation (not sure why - building a monopoly concerns, don't want to spook the competitors?), it's just me pulling a few things together from the AGM preso, FY23 results and ASX material and what Aidan's been saying for a while. So I could be off the mark here and reading into what I want to believe...

Disc: Held (largest position)

Agree with @jcmleng that the standout from the AD8 AGM was the expansion TAM.

I attended the AGM in person (no virtual option) and was surprised to see only a few more people than last year.

A few more analysts (brokers or buy side I presume) than usual but only retail shareholders asked any questions.

I'll add some details in separate straws.

TAM update

My reading of the preso and Aidan's speech is that the TAM has changed in a few ways.

1) More detailed work has been done (via consultants) to arrive at a more granular view of the various markets (although they only shared the 3 high level segments).

2) Fine tuned the definition of each market to only capture revenue pools they can actually capture – i.e. where they have products / solutions in market or planned. For example, this re-cut included removing revenue potential for OEM products that may never be networked.

3) Increased market for each segment but especially in Video ($1.2bn, 39% of total) and Software Services ($1.4bn, 45% of total).

Market Share small but growing nicely

AD8 now has approx. 9% of the Audio Market ($46m of $510m, 17% of total TAM) and approx. 0.5% of Video, leaving approx. 1.5% of Software & Services market by revenue.

The market as a whole is expected to grow at approx. 6% CAGR for next 5 years (grew 8% in FY23).

Given their dominance in Audio (12x their nearest competitor and growing) and their aspirations, with a strong start in Video, I see TAM as a much more relevant for valuing AD8 than for most businesses who discuss it.

Disc: Held (largest position)

Inspired by @mushroompanda's DD on NDI, I asked Aidan (CEO) about them as a competitor a the AD8 AGM last week.

He gave a pretty full answer that left me feeling like he had their number and is quite confident of out-competing NDI over the long term – you would hope he thinks this…

Here's some of his comments (paraphrased from my shorthand).

NDI is probably the tech most like AD8 from a technical POV.

NDI is stronger in stronger in broadcast / live production environments. So they are more market specific, but looking to branch out.

AD8 is stronger in commercial installed AV which is a much larger market.

AD8 have advantages over NDI on price, technology, market and people (NDI have lost a lot of staff).

Dr Andrew Cross (https://www.linkedin.com/in/adjc/) no longer works at NDI (he was their founder / CEO / spirit animal).

In summary, NDI is one to watch and will probably remain the biggest competitor for AD8 in Video.

This needs to be seen in a larger context though which I will discuss in a separate straw on Strategy.

Disc: Held (largest position)

Some great intel and insights to match here @mushroompanda, shows the challenges faced in a "fragmented" Video market as AD8 like to characterise it.

I had got the impression from Audinate Management that video was more complex but they have a play book and it's likely just a matter of time before they do in Video what they've done in Audio.

The big headstart and impressive offering NDI seem to have (and no doubt awareness of the challenge from Audinate in Video) make Video dominance a very different proposition and far from a foregone conclusion I expect.

This raises a couple of potential issues for my Audinate thesis.

Duopoly

Audinate could very well hit up the Video market and gain significant market share, however, if they are doing this via software, or with minimally intrusive hardware, there might be a case for OEM's to use both Dante and NDI - unless there are exclusion clauses in contracts as @mushroompanda suggests there might be.

If this happens, they might end up in a situation like Catapult where they have a lot of customers signed up but they're not exclusive, and the presence of competitors in your customers products severely restricts your pricing power and thereby, margins.

Acquisition

It might make sense, as @mushroompanda suggests for both Dante and NDI to be co-owned and jointly developed for seamless integration and AV industry dominance.

For this to happen one would need to acquire the other or someone bigger acquire both.

The obvious play would be for NDI's owners to acquire Audinate as Audinate is smaller (in revenue terms), stand alone, listed and has a diverse share registry with only Yamaha having a 10% blocking stake.

There's likely a good premium to be attached to a transaction like this but it would prevent Audiante growing into the multi year ASX Compounder that I would otherwise expect it to be.

Disc: Held.

Valuation – statistically expensive as it’s loss making and trades on an EV/Sales multiple over 23x.

The estimate of AU$1Bn+ TAM may prove to be ambitious or take longer to grow into.

COVID may postpone more events for longer and digital transformation may take longer than management expect.

Video dominance is not a given. You can’t simply extrapolate Audio dominance into video – there are more formatting complexities in video than audio and more (although fragmented) competition – as identified by Aidan (CEO) at the 2019 AGM.

If the Video market proves harder or more expensive to crack than management expect, there is a risk of an over / misallocation of capital here.

Disc: Held

Audinate’s TAM (Total Addressable Market) is estimated to be in excess of AU$1Bn annual revenue and growing. It splits this into Audio, Video and Software Services comprising approximately AU$400m each.

Despite dominating the audio market with 17 times the adoption of its closest rival (3,008 vs 173 products), Dante has only 7% penetration of it today, with the legacy physical cabling and connections yet to be digitised, representing a long runway for growth.

Growth - This niche and its adjacent are big enough for Dante to grow at 20%+ for a decade or more but still likely too small for a large, well-resourced competitor to attack profitably.

Audinate’s Economic moat is further expanded as it offers free Dante Certification, with 94,000 AV professionals having gone through the program in the last 2.5 years, driving further adoption.

Founder Management and the experienced Board collectively own 6.4% of the company with CEO and ED Aidan Williams and CTO Geetha Witana (both Co-foundered Audinate in 2006) owning 2.58% / $14.7m & 1.23% / $7m respectively. Aidan invented the initial Dante protocol to solve a problem he had as an amateur musician. Aidan is strongly aligned to shareholders as his holding represents more than 26 times his annual salary and the company is clearly a very large part of his identity.

Balance Sheet - $66m in cash at 2021 H1 should be sufficient firepower to support the growth agenda (along with growing audio revenue) as well as providing a shock absorber if required.

ESG – all ticks, no issues that I can see. Removes cabling (Environment), certification program (Community engagement), experienced board and aligned CEO (Governance).

Edge - The opportunity here is to see the longer-term quality of, and growth in, future earnings when the market is too focussed on high level recent numbers like modest revenue growth and lack of current earnings.

Disc: Held

Rivalry among Competitors (Extremely Low) - Non-existent from existing players (some OEM’s have internal solutions). Dante (Audinate’s product) has 17 times the adoption of its closest rival (3,008 vs 173 products)

Supplier Power (Med-Low) – 1) Software / Developers: Inhouse expertise built from scratch, close to 3 of the big Sydney Universities, Glassdoor reviews positive. 2) Hardware sourced from China and now Malaysian providing some diversification.

Customer Power (Low) – More Original Equipment Manufacturers (OEM’s) use Dante than any other protocol and this trend is increasing. (Note Yamaha were an early adopter and owns 8.25% of shares, but this doesn’t seem to have hurt)

Threat of Substitutes (Low) – legacy analogue (cabling) which is currently the default but is being slowly digitised / phased out. Some OEM’s have their own proprietary system but this is becoming less tenable as it does not allow for the interoperability between other Pro AV brands which tend to be specialised.

Barriers to entry (High) – Too small a market for big players to attack given how entrenched Dante already is.

Disc: Held