Mavenir Systems (NYSE:MVNR)
Thesis: Mavenir is a direct play on 4G/LTE rollout, providing wireless carriers the software needed to deploy native OTT like services resembling Facetime, Skype, and Visual and Video Voicemail integrated with any Voice-over LTE (VoLTE) enabled device and exploit great operational savings through VoLTE by reclaiming bandwidth used in 3G services. The company has signed contracts covering a large footprint of wireless carriers. Its revenue and margins should expand significantly as VoLTE is deployed.
Catalyst: Rollout of VoLTE begins in earnest in late 2014 and in 2015. The new iPhone 6 supports VoLTE, unlike previous models, and should drive adoption of VoLTE by mobile carriers. Both of these events should drive subscriber use much higher than current test deployments by mobile carriers. By 2Q 2015, with the iPhone 6 deployed and VoLTE launches arriving in earnest, the value in the company's existing relationships should unlock.
Our DCF Model gives $35 a share value based on a terminal growth rate in 2019 of 3% and WACC of 13% using conservative subscriber growth. Our DCF model shows significant upside potential versus today's price of $12.70. In addition, Mavenir trades at a low multiple of 0.8x EV/2015 Sales vs 3.0 EV/Sales for similar growth companies, implying a value today of $31. We set our near term target at $32.5 a share. We have adjusted the cash balance and the shares outstanding for the proposed share offering.
The key metrics to watch in this stock are the number of subscribers using their software service to provide VoLTE and Rich Communications Services to next-generation smartphones. One of the things that drew us to Mavenir was the software based nature of their business. While hardware sales are a part of the business, they mainly sell generic servers to the mobile carriers to deploy their software. Going forward, they will sell their services to mobile operators as a software service with annual pricing based on the number of users using their software. This recurring revenue model based on software rather than hardware sales should drive higher margins and ROIC than typical in the telecom equipment industry. In addition, the company sales model is moving from channel driven to direct which will also increase gross margins.
Another data point that gets us excited about the company is the long-term nature of their contracts with the mobile operators. With each contract they've announced, they've secured the opportunity to provide services for 3-5 years plus established pricing for that period of time. This increases revenue visibility and sustainability. Current contracts represent potentially 800 million new software subscribers with currently only 5 million software licenses in operation, according to management.
We've found sell-side models on the company do not accurately reflect its growth potential, as they project growth similar to the previous few years, not taking into account that large scale deployment of VoLTE has yet to occur. Most do not incorporate a subscriber based revenue model. The company should do a better job guiding analysts on this fact. To date, they've provided no ARPU numbers or subscriber numbers to the street that I could find. This information would be helpful in effectively modeling the company and unlocking value in the stock. We've made some assumptions about potential revenue per subscriber per year based on earnings calls and presentation transcripts. For instance, in the Q1 Morgan Stanley Conference, CEO Pardeep Kohli stated:
"Yeah. So, the way I think the data we have provided is that, for doing all this migration cost and operate typically about $15 per subscriber for all the components, which we build and sell. Now, we may not have been selective for everything. So, if they bought only voice from us and then it's about $4; only messaging from us, it's another $4; and core which includes the packet core and Acme Packet type of equipment, session border controller, those things together are $7. So, if you add all of that, that's $15."
Some Key Points:
- According to Ian Maclean, VP of Strategy and Marketing at Mavenir, less than 4% of global users are connected to 4G LTE currently
- AT&T on public record saying they will use generic hardware and Mavenir software to deploy their new 4G LTE networks
- VoLTE deployments just beginning at major carriers:
- "AT&T to launch VoLTE May 23rd in Chicago, Minneapolis becoming the first Tier 1 carrier to do so," according to Engadget
- $38 billion expected to be spent on LTE deployments by 2017 and 24% of this will be on voice and messaging, representing a $9.1 billion TAM opportunity. -Source Gartner
- Managed to land a majority of the largest mobile telecom providers as customers (AT&T [T], T-Mobile [TMUS], Vodafone, to name a few)
- Deployed in 3 of top 4 US carriers and 12 of the top 20 global carriers
- Management sees Gross Margins at 70% long term as most of the forward looking sales are software not hardware with Operating Margins around 21-25% long term
- Recent decline in the stock led by the expiration of the lock up following the IPO in November
One of the concerns I had about the company was the early timing of its IPO. Austin Ventures, North Bridge, Alloy Ventures and Cisco are significant shareholders, and they could act as an overhang on the price as they exit their positions. If Mavenir needed capital, they could have done another round rather than going through a distracting IPO in the middle of product development. I asked the company's management this question, and I thought their answer was good. Essentially, they said that the mobile carriers wanted to see financial strength and regular reporting from the company if they were going to rely upon them for key infrastructure. Mobile carriers felt more secure doing business with a public company with access to public markets than a venture funded start up. My point is, I don't think the company would have gone public at such a low market value had this not been the case. Waiting until the customers had started coming online would have made for more excitement in their near term growth projections and a higher valuation. We are now within sight of that inflection point to higher growth, but we don't think the market has begun to appreciate this. Given the circumstances of their IPO, the VC firms did not sell shares in the offering. In fact, one of the VC partners at Alloy Ventures and a board member has been buying stock in the open market. My thesis is they know Mavenir hasn't really started its material growth ramp, so the VCs feel comfortable sitting on the stock until they do so and the market rewards them.
The company did recently file an S-1, where they will be offering more stock into the market. One big draw back for the stock has been the relatively low float and low trading volume of the stock. The company did not need cash, but does need to increase the float. In addition, once again, none of the VC firms are selling their shares. The cash generated will simply be used to shore up the balance sheet and for future growth needs.
We think Mavenir offers a large opportunity for its clients to save money on deployments by more efficiently using valuable spectrum and rapidly deploy services that can be revenue generators for telecom providers. Mavenir is a leader in Network Function Virtualization (NFV) which enables rapid deployment of telecom services using generic servers and switches rather than proprietary hardware. Voice and data are both services on cellular networks. Mobile data access is vital to the surge of smartphones and tablets use. In parallel, cellular voice has been the killer application to carriers and users for years. In a legacy 3G network, voice calls are supported via the circuit-switched (CS) path, and data are offered via its packet-switched (PS) route. However, the 4G LTE technology decides to use PS delivery only. This poses a challenge for voice support and SMS support as carriers have depended on minutes and SMS billing for revenue, but now have been supplanted by over the top (OTT) applications that simply use the data services to deliver calls and messaging (like Skype, WhatsApp, Apple's iMessage and Facetime). In the new world of mobile, telecom providers increasingly depend on providing faster data services (and billing for usage of data), rather than billing for minutes of talk time and number of SMS messages sent. The new game to allow telecoms to make more money is to encourage more data usage and not worry about how much people talk or text. In addition, switching to all PS services frees up the bandwidth that would have been used for CS path to allow for more data to be sent over the network.
Mavenir's technology allows your voice call or SMS to use your Wi-Fi or LTE IP (or any other IP-based) network while in your home if the quality of the cellular connection is bad. Much of the legacy landline business is now delivered over IP rather than over copper wires into your home. That is why cable providers now offer voice services in their packages as your phone calls are turned into data at the box in your basement installed by your local cable company. This is the same transition that is now happening in cellular phones, but it's just less visible to the users. Rather than your voice call going over a separate switch and path to connect to the other person you're chatting with, it gets transformed into a packet in the phone and travels over the same network as your internet service.
Mobile operators are launching LTE networks and need to continue to provide voice with the same seamless mobility and service parity to that offered on the existing network. At the same time, these operators wish to minimize further investment in their legacy networks, but may not be ready or willing to move immediately to a full IP-based VoLTE. Mavenir' s VoLTE interworking function (VoLTE IWF) provides a unique and innovative approach allowing the rapid launch of LTE services for LTE devices without requiring investment or upgrades in the legacy infrastructure.
Other Paths for Growth
The other big opportunity is for Mavenir to harness the phonebook in the phone as the ultimate social tool rather than current OTT services which are only enabled for people with Facebook, Google, or other social network accounts. Facetime is no good if grandma has an Android phone. Mavenir would enable native video chat services on the phone which would be platform agnostic. This is huge for mobile operators as it takes some of the power back from OTT service providers and enhances the user experience.
Financials Projections and Valuation:
Worth noting, we model negative earnings for 2014 where the company has guided to about breakeven. This reflects our lack of near-term clarity on the mix between higher margin software sales and lower margin maintenance sales. We think our near-term earnings forecasts may be too conservative on margins, as our sales projections for 2014 are mildly higher than the company's guidance of $127 million. The odds are the company is under guiding the street on the revenue side for 2014 to create easier metrics to beat.
Currently, the company's revenues come from test deployments of its technology. Before large telecom providers roll out a new technology, they first do testing in-house to ensure the quality of calls are maintained, that calls won't drop (a meaningful problem for AT&T a few years ago) and other services provide reliable up time. Then, they may deploy to a few select cities or regions before deploying nationally. To date, MVNR technology is largely still in the testing phase at these companies. Revenues have been driven by largely generic hardware sales and small software licensing agreements to support these test deployments. Going forward, the company has reiterated that when these systems come online in late 2014 to early 2015, most of their revenue will be in the form of software licensing on a subscriber basis. Mavenir's contracts with mobile carriers represent 800 million potential subscribers currently and management estimates that will get $7-$15 per subscriber annually if all systems were moved from testing to deployment, potentially generating revenue of around $5.6 billion. This is huge given that their potential install base is closer to 3 billion users around the world. So it is not a stretch for us to estimate that the company could generate $500 million in revenue by 2017 and trade at just 1.5X revenue at that point; we are very comfortable that the stock could go up 3x from here over the next few years. Should they be even more successful, the reward could be staggering.
- LTE has been continually delayed in the US due to network difficulties and spending priorities. True large ramps cannot be expected until mid-2015.
- LTE roaming, while technically feasible, will take some time to deploy.
- An ecosystem of handsets needs to exist to take advantage of VoLTE. Current iPhones for instance do not support VoLTE, although the new Apple (NASDAQ:AAPL) iPhone 6 reportedly will.
- Trading volume is low and liquidity is thin, as float is small compared to shares outstanding. The recent lock-up expiry should increase the float as will the secondary.
In conclusion, we believe MVNR offer a great risk reward with strong valuation support and growth markets. Unlike many SaaS companies, NFV and SDN companies, all future growth is NOT priced into the company. In addition, at such a low valuation, the company could be bait for a takeover from a traditional network equipment vendor like Alcatel Lucent, Cisco, Nokia, or Ericsson who are far behind in Software Defined Networking and Network Function Virtualization due to their reliance on hardware sales.
Disclosure: The author is long MVNR. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it. The author has no business relationship with any company whose stock is mentioned in this article.