Harmonic: Worth The Wait

Mar.25.14 | About: Harmonic Inc. (HLIT)


Harmonic will capitalize on the next video broadcast technology cycle beginning later this year.

The company is also moving into a much larger adjacent market.

Short-term investors have abandoned the name, leading to opportunity for those with a slightly longer time horizon.

Harmonic Inc (NASDAQ:HLIT) is a leading supplier of video broadcast infrastructure to cable companies, telcos, and broadcasters. Its esoteric but necessary equipment accomplishes functions such as video storage, playback, encoding and decoding, encryption, and transmission of video at the cable edge. It is the number one player in most of its markets, has good gross margins, and is solidly profitable. So why does the stock only trade at a multiple of 1x Enterprise value (market cap minus net cash) to revenue?

There is a cyclical element to Harmonic's business where its revenues are driven by technology cycles in the video space. When a new video standard is implemented, this drives a wave of investment as customers need to buy new equipment that will work with the new standard. Currently Harmonic sits in the trough between two standards. A few years ago, the company was growing revenue at 20% as people were upgrading to the MPEG-4 video standard. That cycle matured and the company's growth slowed appreciably. We are now facing the next cycle where a standard called HEVC will roll out and Harmonic will sell new boxes that comply with this standard. The current forecast is that this will start later this year into 2015.

There is also a secular part to the HLIT story which is its expansion into a large new market. Harmonic has traditionally played in the cable edge with a product called an EdgeQAM, which transports the video signal to the end-user cable set-top boxes. What has happened recently is that the standards body has proposed to combine this functionality with the CMTS (cable modem termination system) which is a box that sends data to and receives data from end-user cable modems. The new combined box is called a CCAP (converged cable access platform). This is a much larger market and one that HLIT has not participated in previously. The CMTS market is dominated by Cisco (NASDAQ:CSCO) and Arris (NASDAQ:ARRS) who are racing to incorporate EdgeQAM functionality while HLIT races to incorporate CMTS functionality. So far HLIT and ARRS are ahead of Cisco and both have products in testing with the cable providers. This combined market is 5x as large as the EdgeQAM market so even if HLIT only gains 1/3 of it, they will be far ahead of where they were previously. Another possibility is that either Cisco or Arris buys Harmonic to get the EdgeQAM functionality.

Harmonic has recently cut costs at the opex level and will be reducing R&D once the CCAP device is completed. The company has lots of operating leverage with a 50% gross margin and little need for additional opex investment. This will translate to a rapidly growing EPS line once revenue starts to ramp.

So once again, the question is why isn't the stock reflecting the good times to come? It seems to me that short time horizon investors look at the company's recent results and near term guidance and aren't too impressed. However, if you are willing to look a year out then the picture is much rosier for Harmonic. The company seems to agree with this assessment as they have been buying back stock aggressively over the past six months. I think there is at least 70% upside looking out a year and perhaps more on top of that if Cisco or Arris feels that buying the video technology makes more sense than building it in house.

Disclosure: I am long HLIT. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.