Adtran, Inc. (ADTN) is in the communications equipment industry; it is one of those companies that almost everyone uses, but few people know its name. Recently, the company's share price has bounced off of a low. The substantial decline in the share price was caused by a decline in consolidated revenue which stemmed from a decline in revenue from an insignificant portion of the business.
The overblown decline in the share price caused Adtran to underperform the market; thus, on a forward looking basis, Adtran could outperform the market. I think it will outperform the market.
Adtran's financial position is solid, and I think the company's consolidated revenue should rebound in fiscal 2014. The rebound in the company's consolidated results will increase the intrinsic value of the shares. To me, Adtran is about a two year (2015) investment. The $20 to $24 per share zone is an accumulation zone. The distribution zone is the $30 to $35 per share zone.
- Adtran's operating results may fluctuate in future periods, which may adversely affect the stock price.
- The lengthy approval process required by major and other service providers for new products could result in fluctuations in revenue.
- The dependence on a limited number of suppliers may prevent Adtran from delivering products on a timely basis, which could have a material adverse effect on customer relations and operating results.
- Adtran competes in markets that have become increasingly competitive, which may result in reduced gross profit margins and market share.
- The results from operations may not improve as expected.
Adtran operates two reportable segments: the Carrier Networks Division and the Enterprise Networks Division. The Carrier Networks segment is the larger segment by revenue and gross profit, but the Enterprise Networks segment reported year-over-year revenue and gross profit growth. The Carrier Networks segment is weighing on the consolidated results from operations.
On May 4, 2012, Adtran acquired the Nokia Siemens Networks Broadband Access business. The acquisition provided an established customer base in key markets and complementary, market-focused products. Nokia paid Adtran $7.5 million to acquire Nokia's business.
As of June 30, 2013, the Board of Directors authorized the purchase of an additional 4.9 million shares of the common stock of Adtran.
Adtran offers three major product categories: Carrier Systems, Business Networking, and Loop Access. Carrier Systems are used by communications service providers to provide data, voice and video services to consumers and enterprises. Business Networking products provide access to telecommunication services and facilitate the delivery of cloud connectivity, enterprise communications and virtual mobility to the small and mid-sized enterprise ("SME") market. Loop Access products are used by carrier and enterprise customers for access to copper-based telecommunications networks.
Carrier Systems is the largest product category by revenue followed by Business Networking. Loop Access is the smallest by revenue, but is having the biggest impact on the consolidated results from operations. To be more specific, Loop Access revenue is declining substantially. The decline stems from declining revenue from HDSL, which is categorized as a legacy product. The share price decline may be overblown as the decline in revenue stems from a minor portion of the business.
Many of Adtran's solutions are currently in use by every major United States service providers. The company plans to maintain and increase market share by following a low-cost strategy. Consequently, Adtran needs to increase unit sales more than the unit price declines to increase revenue. Obviously, I would prefer a company that is able to increase price per unit sold and quantity per unit sold, but the low-cost strategy has worked for Adtran.
The key takeaway is that the share price declined substantially because of a decline in revenue from a small portion of the business. That said, I expect revenue to stabilize and growth to resume which could result in a substantial increase in the share price.
- Adtran announced that TalkTalk Business is using Adtran's NetVanta IP Business Gateways to deliver its new advanced IP-ISDN30 service. The service, designed to provide growing enterprises with robust and flexible communications at 50% lower cost than traditional ISDN, features a NetVanta 6310 gateway at each customer site.
- The company announced that Lintasarta has chosen the Total Access 5000 broadband platform as the backbone of the company's Fiber-to-the-Premises (FTTP) service roll out. As Indonesia's largest telecommunications provider focused solely on enterprise customers and servicing most of the businesses in the country, Lintasarta is deploying FTTP to deliver faster broadband speeds for business services that demand service level agreements for continuous service performance and availability.
- NetVanta UC enables Alabama school system to deliver advanced networking technology in-classroom and across the district.
- Adtran announced it has enhanced its technical services and support programs. The new ProServices program includes unique ProStart installation programs, ProCare maintenance programs and ProCloud managed networking services.
I think Adtran can grow at a long-term growth rate of 5%. Also, I think the company's revenue decline is closer to bottoming than starting. Thus, I'm going to model revenue growth in fiscal 2014.
In fiscal 2013, I think revenue declines about 5% to $590 million. I think the operating margin will expand to the 10% to 15% zone, and the net profit margin will expand to the 8% to 12% zone.
I'm modeling revenue of $643 million in fiscal 2014. I think the operating margin will get back to the 20% to 25% zone, and the net profit margin will get back to the 15% to 20% zone.
Thus, my forecast is bullish for the share price and valuation. I think that margin expansion will be a major contributing factor in the increase of the valuations.
Adtran is very liquid and doesn't carry much debt. Further, I think the asset utilization will improve as revenue resumes its upward trajectory.
Plus, the company is buying back its shares, which in this case suggests management probably thinks that the shares are undervalued in the market.
I'm going to use discounted cash flow models and multiplier models to value the common equity shares. The average of the three valuation methods is the intrinsic value of the shares. The current share price is $24.90.
My discounted cash flow model suggests the fair value of the common equity shares is $24. The value could range from $18 to $36. Based on this method, Adtran is fairly valued.
Next, I will use a justified value to determine the intrinsic value. Based on my model, the justified PE ratio is 20; the current PE ratio is 48.5. The justified PE could range from 10 to 30. The intrinsic value using this model is $10.27; this model suggests the shares are overvalued.
Now, I will use the historic average multiplier model values. The intrinsic value using the price/earnings ratio is $9.50, using the price/book ratio is $30.31, using the price/sales ratio is $26.89, using the price/cash flow ratio is $22.58. The average of those values is $22.32; this model is saying that the shares are fairly valued.
The average of those three models is $18.86; thus, the valuations suggest Adtran is overvalued by 32%, which is possible given that revenue is probably still declining. That said, the share price bounced off of the $18 level earlier this year.
All of that said, the zone to get long is the $20 to $24 zone. This company's earnings will rebound as some charges are excluded from future periods and management does some cost cutting. So, the justified PE intrinsic value, which weighed heavily on the intrinsic value, will be higher in future periods. Also, the price/earnings ratio intrinsic value will be higher.