My previous article discussed Ubiquiti's (NASDAQ:UBNT) business model, early day's performance, business risk, Q3 14 results. This article reviews Q4 14 and FYE 6/14 results, reaffirms the exceptional value creation model of the company, and revises the estimated fundamental value of the company's common stock ($64.0/share).
Strong Value Metrics
Table 1 shows selected metrics for the last four fiscal years, the latest quarter's year over year comparison, and estimates for FYE 6/15. The metrics show exceptional ROIC and exceptional revenue growth, together drivers of shareholder value creation.
|Table 1. Ubiquiti Networks Value Metrics|
|(Amounts in millions of US$, unless otherwise noted)||FYE 6/11||FYE 6/12||FYE 6/13||FYE 6/14||4-Yr. Avg.||FYE 6/15 (NYSE:E)||4Q 2013||4Q 2014|
|NOPAT / Revenues||25%||29%||25%||31%||28%||30%||29%||31%|
|OC / Revenues||11%||13%||3%||13%||11%||12%||2%||12%|
|ROIC = NOPAT / OC||226%||225%||1005%||235%||423%||247%||1441%||251%|
|EVA = (ROIC - WACC) OC||47.47||99.36||80.68||170.73||99.56||189.93||29.02||45.73|
|FCF (NOPAT - Inc. in OC)||n/a||79.65||119.65||110.57||66.43||193.78||67.38||-20.11|
|FCF / Revenues||n/a||23%||37%||19%||20%||29%||67%||-13%|
|R&D / Revenues||6%||5%||7%||6%||6%||6%||5%||7%|
|NOPAT (Net Operating Profit after Taxes) = EBIT (1 - Tax Rate)|
|OC (Operating Capital) = NOWC (Net Operating Working Capital) + OLTA (Operating Long Term Assets)|
|EVA (Economic Value Added) = (ROIC - WACC) OC|
|FCF (Free Cash Flow) = NOPAT - (Changes in OC)|
|EV (Enterprise Value) = Present Value of prospective FCF, growing at g; discounted by WACC (estimated at 10%)|
- Q 14 exhibited solid product demand y-o-y in Service Provider Technology (airMax, EdgeMax, airFiber; revenues increased 54%) and in Enterprise Technology (UniFi, enterprise WLAN, airVision, mFi; revenues increased 188%).
- FCF declined in 4Q 14 y-o-y to minus $20.1 million principally due to $67.7 million increase in OC ($30.5 million increase in inventory and $19.0 million increase in receivables). Notwithstanding the increase, investment in OC is modest relative to revenues (FYE 6/14 OC / Revenues = 13%), particularly in consideration to hefty NOPAT margins. Increase in inventory (including unusually high pre-build for airFiber5 in 3Q 14 due to expected high demand from the get-go) was due to new product inventory and ordinary inventory build up to prevent delays in delivery to distributors.
- In FYE 6/15 revenues are expected to grow 17% to $669.4 million. Prospective revenue growth is supported by new and recent products including EdgeSwitch, Unifi Video, Unifi VoIP and Software Defined Networking products (not yet available for distribution during Q4 14), airFiber5, airMax. Continued expansion in R&D (84% growth in 4Q 14, y-o-y) will continue to fuel future growth. FYE 6/15 FCF is expected at $193.8 million, a 75% increase over FYE 6/14.
- Exceptional four year average ROIC (423%) creates substantial EVA. A corollary is high EVA relative to Operating Capital, connoting exceptional efficiency in the use of capital.
- Strong value metrics are mutually re-enforcing; and consistent with a model focused on R&D driven technological leadership, an effective sales cost structure supported by a self-supportive internet-based eco-system of users, low capital intensity, and products with disrupting price-performance characteristics.
Q4 14 Management Comments
- CEO Robert Pera: "We continue to ramp our R&D resources in an effort to accelerate the next phase of our long-term vision of democratizing end to end communications technology infrastructure for the unconnected"
- In Q4 14 the company entered into a lease for manufacturing space in China, initially to support product development and prototyping of new products. Paraphrasing CEO Pera, the purpose of the investment is to accelerate time-to-market for new products by shortening the time between product concept and mass production, and preclude millions of dollars in revenue losses associated with delays to market. A company controlled factory with some vertical integration, especially on the mechanical side and the prototype production stages of project development, ought to reduce months in the time-to-market for new products.
- Regarding the impact of a potential reduction in spectrum by regulators, CEO Pera indicated that although it would be a negative for the industry, it would not prevent Ubiquity (airMax) to continuing to grow in the USA --due to the fact that substantial R&D investment over many years has been directed toward making products that are spectrally efficient and immune to noise. Furthermore, most of the growth is now outside the USA.
- Regarding prospective potential of switching and voice combined, CEO Pera: "We released EdgeSwitch, which is under our EdgeMAX product line, which is really meant for a variety of applications, especially with our service providers. And a lot of them are pairing them with airMax, a lot of them are using them for video security deployments and just general small medium business use. It's hard to say. I believe that will end up being a pretty significant material product line for us. I can't really say what the growth is going to look like over the next few quarters. I will say, though, that we will have, in UniFi, which is our SDN platform for the enterprise, we will have a switching product line for UniFi. And that becomes powerful because we have somewhere on the order of probably close to 2 million UniFi APs deployed in the world, and we have a Software Defined Networking centralized control point. And what you'll see in our next version of UniFi 4.0, you'll see it become much more than just WiFi. And the system integrators will see how you could add switching to your WiFi network or add security gateways or add video cameras. And because we have such a big deployed base of UniFi, once we bring our same-switching technology under the UniFi SDN platform, I think you'll see instant traction because we just have so many deployments out there. So when you factor in the UniFi switching combined with the EdgeMAX switching, I think switching will be a large material contributor for us. And I think you'll see pretty good sales numbers, I'd say, calendar year 2015, definitely in the millions, maybe to tens of millions."
- Q1 15 Forecast: Revenues of between $156 million and $161 million, GAAP Diluted EPS of between $0.51 and $0.53.
Exceptional Value Creation Model
Q4 14 performance and strong value metrics re-affirm the staying power of Ubiquiti's business model --defined by the interaction of the following components: Value Proposition, Economic Returns, and Management Effectiveness.
- Value Proposition (benefit received in the eyes of clients). Strong benefit is derived from clients who use Ubiquiti's products. Performance/price advantaged products lower the clients' costs and enhance their productivity. Customer service leverages on-demand information access through the internet. A large community of service providers, distributors, value added resellers, systems integrators and information technology professionals, who along with the company's engineers are actively involved in real time in product development and product servicing. Such a network is open to participants, easily accessible and cost effective. The network system saves marketing and relationship management costs to the company, which savings are passed-on to benefit clients with products of great value content (high NOPAT / Revenues). In so doing, the company "democratizes end to end communications technology infrastructure for the unconnected", in the words of CEO Pera.
- Economic Returns (for the benefit of shareholders). Financial results and value metrics examined in this article point to consistent creation of value for shareholders while delivering the value proposition to clients. In other words, the allocation of resources (mostly through high tax-advantage R&D investment, low fixed assets expenditures, low OC) in support of the value proposition yields attractive economic returns for shareholders (high ROIC, high FCF growth, high EVA). Embedded in the economic equation is strong client benefit and strong pricing power relative to value provided (high NOPAT). These translate into healthy margins, low capital utilization, and attractive returns on capital. Important in the assessment of economic returns is the relatively low level of risk inherent in the company's business; and low financial risk due to the ability to service a relatively modest amount of debt. Low risk and modest debt are conducive to low cost of capital and strong fundamental value.
- Management Effectiveness (adequacy of strategy, competent allocation of resources). Management actions are the causal element in the performance of the company. It involves overall business direction and execution; recruiting and incentivating intellectual power, developing technology, nurturing core competence, running a performance-based organization, managing the stakeholders' eco-system, allocating capital juditiously, and maintaining risk within management's risk-taking ability.
- CEO Pera deserves very high marks for his imprint in values, strategy, and for the management style of his product-driven, easy access, open forum, and meritocracy-focused organization. Management is an effective force in the achievement of both, the value proposition and attractive economic returns.
The estimated fundamental value of the stock is $64.0/share, based on the present value of future cash flows discounted at the cost of capital. Inputs are as follows: $193.0 million FYE 6/15 FCF growing at 12% per annum through 2017, 10% in 2018, and 5% thereafter in perpetuity. WACC is 11% through 2017, 10% in 2018, and 9% thereafter.
Disclosure: The author is long UBNT.
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.
Additional disclosure: The material presented here is for informational purposes only. Nothing in this article should be taken as a solicitation or recommendation to purchase or sell securities. Before buying or selling any stock, you should do your own research and reach your own conclusion. Views and opinions in this article may be wrong. The analysis, including financial computations, presentation, and views, do not necessarily conform to any sanctioned or accepted standard. Presentation and computations entail a probability of error, which is entirely possible. I am not an investment management professional. Please do not rely on this material, do your own due diligence.