Megaport Share Slide Overdone?

This story features MEGAPORT LIMITED. For more info SHARE ANALYSIS: MP1

Despite a share price savaging upon the release of second quarter results, brokers are generally upbeat on Megaport’s outlook.

-Brokers remain positive on Megaport
-Reasons for the share price fall
-Morningstar identifies key metrics to focus upon
-Accelerated sales expected after short-term pain from a new sales strategy

By Mark Woodruff

In the eight months leading up to last November, the share price for Megaport ((MP1)) had doubled to a high of $22.

It’s not hard to warm to a company whose fortunes are tied to such grand themes as the cloud and data centres. The global network-as-a-service provider enables firms to easily and flexibly purchase dedicated data connections to service providers. This especially pertains to cloud service providers including Amazon, Microsoft, Google and many others on the platform.

In recent times the Megaport share price had drifted back to just north of $18, until an around -16% plunge upon the release of second quarter results last Wednesday. What was the main cause of the share price fall and is the cause structural in nature?

UBS feels a slower ramp-up for the Megaport Virtual Edge (MVE) product was the likely culprit behind the share price reaction. The product enables branch-to-cloud connectivity on the company’s global software-defined network. The broker had expected the sale of an additional 20 MVE’s for the quarter instead of 12.

In addition, Macquarie believes switching to channel sales impacted upon Megaport's margin improvement in the second quarter. While the analyst forecasts the sales strategy will offset positive operating leverage in FY22, an upward inflection should occur in FY23.

Despite these concerns around MVE and margins, brokers generally remain positive on the stock.

Morningstar in particular calms the waters by noting that growth for many metrics reported by the company have historically been choppy. There’s considered to be no worrying signs and the overall opportunity and growth momentum remain intact. The stock is now trading near Morningstar’s fair value estimate of $16.

Where should investors focus?

Impressively, annualised recurring revenue grew by $7.8m in the second quarter or an annualised growth rate of 47% to $110m.

There are many other metrics that could be relayed though Morningstar suggests investors focus upon whether the company continues to add customers at a good rate; that its customers continue to use more services; and that pricing does not suffer as it adds customers.

Citi runs with this focus and points out the key positive from the result was the record customer additions for any December quarter to-date. This bodes well for the future as customers typically take up services over time.

Megaport added 123 incremental customers and 439 incremental ports over the quarter, an improvement on the first quarter results.

Also, customer additions included 60 Megaport Cloud Router (MCR) customers, which Citi considers a positive as spend per MCR customer is typically higher and churn is generally lower.

Switching to a direct sales channel

Megaport continues to build out its indirect channel and cash outflows for staff costs increased to $28m. Ord Minnett, which upgraded its rating to Hold from Sell on valuation grounds, expects some operating deleverage in the first half as a result of this investment and believes it will take time for new hires and relationships to add incremental top-line growth.

Morgans agrees and feels the aggressive investment in channel over the first two quarters should drive an acceleration in sales in the coming quarters.

Similarly, UBS expects the indirect sales strategy should gain momentum in the March or June quarter after the launch of VantageHub, a one stop platform for Megaport PartnerVantage partners to manage their Megaport business.

The recently announced partnership with US-based TD SYNNEX is also expected to make Megaport’s global, private Software Defined Network (SDN) platform available to a wider range of customers. UBS retains its Buy rating and eases its target price to $21.75 from $22.00.

As a result of costs incurred in the new sales strategy, Macquarie’s delayed margin improvement forecasts have led to volatile percentage earnings changes as the company transitions from loss to profit. The analyst now forecasts earnings will turn positive in FY24 (previously FY23) and lowers its target price to $20 from $24, while retaining its Outperform rating.

Outlook

The key for 2022 is for the indirect channel to ramp-up, especially for Megaport Virtual Edge, which in Citi’s view represents a source of upside over the medium-term.

Morgans concurs and notes a key share price driver is an acceleration in sales in the second half of the financial year to prove MVE is a large mass marketable solution. The broker lowers its target price to $16.49 from $17.71 and retains its Hold rating.

Overall, FNArena’s database has five broker ratings with three Buy and two Hold ratings and a consensus target price of $19, which suggests 22.8% upside to the last share price.

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