Audinate Forging The Future

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As investors increasingly focus on technology companies, it is timely to review the investment thesis for Audinate.

-Audinate is the global standard in digital audio networking 
-Network effects are becoming more relevant
-Target prices increase after company update

By Mark Woodruff

Technology has become a key focus for investors in recent years, despite remaining a small portion of the broader Australian share universe.

This interest culminated in the formation of the ASX All Technology Index back in February this year, just prior to the pandemic-induced meltdown. 

Despite this hiccup, the value of the index has climbed to 2,650 points from approximately 1,800 points upon listing. Over the last three months the index has added $33 billion in value. Appearing in the top ten by market capitalisation are names including Afterpay ((APT)), Altium ((ALU)) and Appen ((APX)).

Stockbroker Shaw and Partners believe Audinate Group ((AD8)) should be included amongst this august group of A’s when thinking of impressive Australian technology companies. While significantly smaller in size, the company is already included in the All Technology Index of 58 companies. However, the broker warns some semblance of caution is required until clarity around earnings transpires.

The company’s product, named Dante, has attained the position as the global standard in digital audio networking and has a significant addressable market with limited competition.

Audinate – A Users Guide

When the following definitions and examples are used in conjunction with the diagram in Figure1 (below), it should help to clarify Audinate’s products and business niche. Ultimately this will assist in illuminating the overall investment thesis.

Audinate has three business segments audio, video and software. The company is leveraging its audio dominance into synergistic verticals with a combined total addressable market (TAM) of over one billion dollars.

Dante replaces point-to-point audio and video connections with easy-to-use, scalable, flexible networking. Networked AV (audio visual) technology is a relatively new concept. It uses the power of the network to distribute content wherever it is needed.

Dante has been adopted by hundreds of original equipment manufacturers (OEM) in thousands of professional products. When any audio or visual system is installed for commercial use it is referred to as Pro-AV. The company's clients are the largest global OEM’s including Bose, Yamaha, Shure and Sony, who sell Pro-AV products (speakers, amplifiers and mixers) to system integrators. As an illustration, end users include universities, corporates, convention centres, theatres, stadiums, zoos, theme parks, recording studios and houses of worship.

Finally, the term AVoIP or (AV over IP) stands for “Audio-Visual over Internet Protocol”. Essentially, it is the transmission of audio-visual data over a network such as a LAN, WAN, or the internet.

With traditional audio visual setups, wires and cords only add complexity to the presentation. As an example, presenters sharing the same stage must share plugs and cords. This creates delays and potential technical difficulties.

Wireless presentation technology enables a new approach to meeting collaboration by allowing attendees to plug in to the meeting wirelessly and participate in ways that had previously only been imagined. The cables are not based on circuits but packets. With this technology, you do not have to place receivers at every device.

Network Effects

Network effects are becoming more relevant for the company as the structural shift to networked AV unfolds and it becomes harder for OEMs and users to adopt alternatives, according to Morgan Stanley. 

Networks are one of the most powerful competitive advantages a business can possess. Strong network effects make it difficult for businesses to be replicated, enabling long-term pricing power. 

Outlook and Focus on Growth

Back in July when the company raised $40m of capital, UBS felt the right strategic steps to emerge stronger had been taken.

And now, with growth opportunities ahead across all three segments, Morgan Stanley thinks Audinate will be running the business for growth, not profitability, in the coming years.

The broker suggests the competitive position is improving, but transitory headwinds have masked underlying earnings power. It’s considered top-line re-acceleration will occur from FY22 and this is being underestimated by consensus views. Also, the structural growth story remains intact and risk-reward is compelling at these levels, according to the analysts. 

UBS also believes the focus should be on growth metrics and the company has an opportunity during covid-19 to step up cost reinvestment to further entrench its competitive moat. This could put pressure on short term earnings. However, the broker's Buy rating is predicated on a greater than twelve month view. 

The robust balance sheet at financial year end and stronger-than-expected operating cash flow for FY20 appealed to Shaw and Partners when releasing a late September update. The broker made special mention of the first indications for merger and acquisition activity potential, either in software, platforms or video. 

First Part Of The Investment Thesis – Networked AV adoption

Morgan Stanley believed Audinate's growth trajectory has been rebased materially lower by the market, prior to a recent first quarter update.. However, recent industry feedback and decision-making clearly showed the broker the networked AV growth trend should continue. Over the past two to three years, there has been over 20% growth.

Having seen structural shifts evolve in other categories like VoIP and cloud computing, the broker has conviction in the longevity of the networked AV migration.

According to a September survey published by commercialintegrator.com, readiness to fully embrace AVoIP has significantly increased in 2020 from 2019. And this readiness has been and will continue to be reflected in more networked AV installations, asserts Morgan Stanley.

The broker believes covid-19 has further accentuated the benefit of networked AV versus incumbent solutions, and the industry is not going back. Customers are increasingly looking for quality, flexibility, and scalability in their AV infrastructure to address whatever the "new normal" looks like.

The analysts explain there is a natural transition that will take place to continue adoption. It’s considered once Dante has been integrated in one product, incremental integrations get easier and become part of an OEM's future product roadmap.

Audinate is also assisting in the acceleration of adoption by making new Dante implementations available (such as software). This will make it even easier and more cost-effective for OEMs to integrate, explains Morgan Stanley.

Second Part of The Investment Thesis – Competitive Positioning

A lower forecast revenue trajectory by the market implies little conviction that Audinate’s competitive position is getting better, explains Morgan Stanley. Additionally, there is little belief the company will continue to take market share when conditions normalise post-pandemic.

However, the competitive position is fully intact and the company’s ecosystem (see network effects diagram above) is clearly strengthening, according to the broker. Dante-enabled product registered 31% growth in FY20 and the company’s interoperable product ecosystem is now eight times that of the nearest competitor (Cobranet). Additionally, Dante certifications doubled in FY20 after also doubling in FY19.

Canaccord Genuity agrees and says despite the number of projects system integrators could bid on falling away, OEM partners are advancing the number of networked products released to the market. As a result the company reported the largest six month increase of networked products in the second half of FY20.

Continued ecosystem growth should enable the company to continue taking market share. The analysts at Morgan Stanley have forecast compound annual growth rate (CAGR) for Dante units at 25% for FY20-23.

Networked AV still makes up small percentages of total OEM product portfolios. This implies to the broker plenty of ecosystem growth.

Also, Dante training is delivered live via on-demand videos. Training is important to for competitive positioning, highlights the broker, as it keeps users in the Dante ecosystem and creates lifetime value. 

UBS agrees the company can strengthen its competitive position through industry Dante/digital AV training and further entrenching the Dante network (2,804 products as at June 30).  Additionally, the broker highlights the video and software opportunity, with "encouraging" progress of early licensees. 

Final Part of The Investment Thesis – Revenue Upside

While Audinate is not immune if the entire industry is not spending, once that returns Morgan Stanley expects the company to capture a much larger share with expanded adoption. The broker’s projection of 23% revenue CAGR for FY20-23 is materially is backed by adoption growth and still below medium-term guidance of 26-31%. However, if recent industry volume estimates are to be believed, there is potentially another 20% upside to the FY23 revenue forecast.

Morgan Stanley thinks the market has not appreciated the link between Audinate's growth in underlying monetisation potential (which is independent of cycles) and future earnings power.
Instead, up until the first quarter results the market had extrapolated forward estimates from transitory near-term headwinds and what FY21 growth looked like.

Market share growth is a main driver of the broker’s conviction. However, it’s considered additional upside will result from continued progress in video and software. These will likely also contribute to revenues in FY23.

The broker does temper FY21 estimates slightly, but factors in normalisation in FY22. This is driven by an industry rebound, but more significantly, by Audinate continuing to compound OEM/user adoption, driving those market share gains. 

To counter the above positivity, Shaw and Partners focus on the covid-19 impact. Due to the slowdown in economic activity, many infrastructure facilities which were formerly likely to use Dante are now shut.

However, the broker points out the various operating expense levers the company has the ability to ‘flex’. This includes employees, marketing, travel, administration, corporate, discretionary and other costs. Previously, R&D/engineering expenses were forecast to double over the next two years. The analyst suggests this is an easy cost to curtail until conditions improve.

First quarter update (on 15/10/2020)

The first quarter update shows transitory headwinds are abating, says Morgan Stanley, resisting the ‘I told you so’ urge. The broker previously had the highest target price and  recently reiterated an Overweight rating based on underappreciated industry adoption and competitive position.  It was considered consensus had underestimated the sharpness of a potential rebound. Morgan Stanley retains a price target of $7.50.

Sales are back to pre-covid levels, which in UBS’ view de-risks FY21 revenue forecasts. The result was considered particularly strong given the challenging macro conditions and the revenue for the highest value product (Brooklyn) was significantly down year-on-year (impacted by live events). Additionally, with new project activity returned, the company will re-commence the previously planned reinvestment into the cost base. However, the broker cautions it is unclear whether the first quarter result may have been driven by a short-term boost from education and corporate outfitting (adapting to the new covid-19 "Zoom" environment). An alternative interpretation is audio fit-out projects are coming back and digital is taking market share, explains the analyst.

Whatever the case, UBS believes the long-term opportunity remains intact and lifts the target price to $8.00 from $7.35.

In upgrading Audinate’s target price to $8.00 from $5.30, Credit Suisse now has an increasingly upbeat view of corporate/education growth to offset live events challenges. Selected products such as Adapters, Ultimo, Broadway and Retail Software are experiencing “strong growth” versus FY20.

Corporate (not live events) is the biggest end market for Pro AV and the broker believes corporate penetration is likely to see structural acceleration post covid. Flexible/remote working and reduced business travel are considered to be accelerating structural growth in corporate audio/video requirements (particularly unified communications). As a result, the analyst can still see an ample penetration opportunity, from which  Dante is well placed to benefit.

Monthly sales have been steadily improving sequentially, with the worst of the covid-19 impact appearing to have passed, thinks Credit Suisse. Dante increasingly appears to the broker as the de-facto networked audio standard which drives penetration in audio. In addition, further opportunities are expected to exist across video and services.

Canaccord Genuity had not updated it's stance at the time of writing to incorporate Audinate's first quarter update. However, the broker believed the e current share price weakness presented an opportunity to incoming investors who can take a long-term view given the company's deep tech expertise (which is limited on the ASX), market leadership position and incremental growth at elevated earnings (EBIT) margins.

While acknowledging the better-than-expected first quarter sales figures, Shaw and Partners would be be more positive in buying the stock under $6.00. 

In a slightly scathing assessment, the broker would like to see the company improve its earnings transparency to the market, with more quantifiable measures and detailed key metrics that can be tracked and compared.

However, the analyst believes it is ‘a ripper of a story’ with compelling attractions and a clear earnings runaway. Shaw lifts its 12 month target price to $7.25 from $5.75.

FNArena's database has two Buy ratings and one Hold (Credit Suisse) for Audinate. The consensus target is $7.83, suggesting 17.6% upside to the last share price. 

Both Canaccord Genuity (Buy/Target $5.70- pre first quarter update) and Shaw and Partners (Hold/Target $7.25) are not part of the group of seven brokers monitored daily on the FNArena database, but appear in the wider FNArena universe in The Australian Broker Call *Extra* Edition. This additional news report is updated “regularly” depending on availability of suitable quality content.

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