"We are now playing in the big rules game and the big guys game." - Rami Hadar, CEO of Allot Communications
In late April, Infonetics Research published a paper proclaiming Allot Communications (ALLT) the 2012 overall market share leader in Deep Packet Inspection [DPI]. DPI-based solutions identify and leverage the business intelligence in data networks, allowing operators to capitalize on the network traffic they generate. Service provider DPI product revenue totaled $596 million worldwide in 2012. Allot got about $100 million of that market. Infonetics attributed the company's advance to increased sales in the Americas, and boosted revenues from APAC.
According to the report, Allot pulled ahead of Sandvine (GM:SNVNF) to take the overall DPI revenue market share pole position. This was Allot's first time as leader in the space. System integrators Cisco (CSCO), Ericsson (ERIC), and Oracle (ORCL) (with their recent acquisition of Acme Packet), also compete in this field. However, it's stand-alone Allot that topped the wireless DPI segment, while Sandvine is number one in fixed-line DPI. Fixed-line DPI is a more mature market which diminishes growth. If Allot can maintain their advantage in wireless, they could experience double-digit gains going forward. The wireless DPI sector is projected to grow at a CAGR of 33% through 2017.
This glowing news did nothing for Allot's stock price. Because of belt tightening with Tier 1 telecom service carriers, Allot has missed their numbers for a few quarters. They now trade at $12/share, near the bottom end of their 52 week range of $11-$30. Lackluster earnings reports, an overall decline in the markets (August was the worst month since May of 2012 for the S&P 500), and an expansion of Allot's core competency, has put the share price under tremendous pressure.
(Chart Source - Yahoo Finance)
I recently took a position in the company because of their reasonable valuation and superior technology. Nevertheless, I've got them on a short leash. After reading the May 7th, Q1 conference call transcript, and the August 6th, Q2 conference call transcript, I have decided to make Allot Communications a short-term investment. I believe the stars are aligned to see a nice pop in the equity's price in the next six months. However, if they begin to give guidance, I would reconsider my position for a longer duration. As is, they only provide qualitative information, and as far as numbers are concerned, they only state the book to bill ratio.
The book to bill ratio is the ratio of orders received to units shipped and billed for a specified period. In Allot's circumstance, it's for each quarter. In the latter half of 2012, and the early part of 2013, the company had a book to bill ratio less than one. In the past two quarters it was over one. A ratio of above one implies that more orders were received than filled, indicating strong demand, while a ratio below one implies weaker demand. You can see why the equity sold off this year if you utilize this metric. You can also wonder why the security didn't rise with the book to bill at one plus.
In Q1, Allot had the first sequential decline in top line revenue after 15 quarters of consecutive growth. The primary cause for the sequential decrease in revenues was the softness felt in EMEA [Europe, Middle East, Africa] during the second half of 2012. The revenue decline also resulted from normal first quarter seasonality. This softness in EMEA still hounded the company in Q2. A $5 million deal with an EMEA Tier 1 fixed-line operator has been delivered; however, revenue recognition has been delayed to the second half of 2013.
However, business didn't stand still for the company. As they stated in their press release concerning quarterly achievements:
- During the quarter, large orders were received from 13 service providers, 3 of which were new customers. (Typically, 60% to 80% of revenue comes from follow-on orders from existing customers. 40% - 20% comes from new clients)
- Six of the large orders came from mobile-service providers, two of which were new customers.
- Secured orders from three of the world's top ten telecommunication operators to assist in their LTE network rollouts.
- Cash, cash equivalents, short-term deposits and marketable securities totaled $134.7 million with no debt.
- VAS [Value Added Services] accounted for 26% of total bookings.
The last bullet point highlighting Value Added Services is a key selling point for Allot when they market their products to the Tier 1 telecom companies. Management believes this is a tremendous growth opportunity going forward. This can be illustrated by the fact overall revenue in VAS went from 15%-20% in 2012, to 26% in the most recent quarter.
As data usage over mobile networks continues to rise, operators are adopting solutions that not only manage the increased traffic, but include specialized capabilities like video optimization, content caching, and usage-based billing.
CEO Rami Hadar in the most recent quarter:
In terms of the product leadership, I believe that we have a very strong product in terms of scalability, on one hand and also in terms of the features, on the other hand, which each one relates to an advantage versus our two other competitors. On top of that, we are quite unique in our Value-Added Services offering, and that's the key differentiator and sometimes it makes the whole difference in winning.
In Q1 he also discussed VAS:
After spending large part of 2012 executing cost-cutting and layoffs, some of the more advanced operators realized that they need to move past saving and into monetization and differentiation rather than cutthroat pricing competition. The strategies vary, but current trends around opting Value-Added Services, such as Parental Control; premium services such as high-quality video delivery; and early trials with application-based charging. We believe that the commercial success and rate of acceptance of these new offering by end users are important drivers for our future growth.
Currently, Parental Controls is the leading charge, but DDOS [Distributed Denial Of Service Attack] is also coming on strong. Enclosed is a chart spotlighting the potential revenue streams for Allot in Value Added Services.
(click to enlarge)
(This chart was obtained from an interview with Allot's AVP of Marketing Jonathon Gordon)
In addition, to buttress their leading position in the DPI sector, the company has expanded their product portfolio the last two years. This includes recent acquisitions of Ortiva Wireless and Oversi to enable Allot to offer integrated solutions. I think this is a key point because now Allot will compete with global video caching companies such as Akamai Technologies (AKAM), and Application Delivery Networks like F5 Networks (FFIV).
I believe that this transition from a stand-alone company to an integrator may be putting additional pressure on the equity as Wall Street waits and sees how well Allot does on a much larger stage. They are also an Israeli company and the conflict in Syria may have caused the security to sell off even more in the past two weeks with the world waiting to see what the United States' involvement will be. Nevertheless, Allot's lifeblood is DPI with the major telecom carriers, and I'm betting that delayed orders will be signed, sealed, delivered. They've got a long track record of selling to the telecommunications industry, and no longer have to evangelize their mission.
You can get really granular discussing the technology of some of these telecommunications companies, but it's the numbers that count. The short float is only 7.7%, so Wall Street seems to believe that shares may be adequately valued. Price/Sales is 4. Price/Book is 2.38. Cash/Share is $2.90. Not dirt cheap, but still very reasonable for a small-cap technology firm with a fairly substantial track record and good prospects.
According to Yahoo Finance, consensus earnings estimate for 2013 is $0.15/share, but that figure jumps to $0.48/share for 2014. We're already in September and analysts begin looking to the next year's numbers in early Fall. Sales growth is projected to be 22% for 2014. That may prove to be a conservative extrapolation if integration initiatives begin to pan out. However, they will be going toe to toe in bake-offs with F5.
With only $100 million in annual revenue, this is a small company attempting to do battle with some formidable opponents. However, telecom carriers prefer Allot's DPI solutions, and could allow a more integrated approach if Value Added Services continue to pan out. I believe at $12/share, it's a decent bet for price appreciation going into the New Year.