Seeking Alpha
Randy Durig, Durig Capital (108 clicks)
Bonds, registered investment advisor, portfolio strategy, foreign companies
Profile| Send Message| ()  

RadiSys (RSYS) is a leading provider of embedded wireless infrastructure solutions for telecom, aerospace, defense and public safety applications. Its market-leading hardware, coupled with world-renowned Trillium software, services and market expertise, enables its customers to bring high-value products and services to market faster with lower investment and risk. The following review will tell why we consider RadiSys to have excellent monopolistic potential, and why we are adding it to our Monopolisitic Potentials Portfolio.

Introduction

During the process of a turnaround, in spite of having fast expanding new business products lines and end of life solutions for old business, RadiSys was caught in a rough market. RadiSys has an excellent reputation among its peers, with many peer reviewed awards. New products and software sales account for over 67% of current sales, which according to its last quarter results are growing at over a 60% annual rate. However, this robust growth is hidden by the declines in two of its older revenue streams, the largest segment having fallen off by 60% in the last year. This glaring sore spot now accounts for only about 16% of revenues, and our research inclines us to believe that any division contributing less than 30% of revenues (whether rising or falling) will have difficulty substantially distorting the overall business profits, especially when the margins for that division are as narrow as they are here for RadiSys.

Developing a strong growth business with better margins

RadiSys, and the newly acquired Continuous Computer, is developing a very strong business presence in the fast growing wireless industry with many top tier value added resellers utilizing their well accepted and leading products. Its new business model, when measured by its growing eco-system, appears to be well hedged with firewalls designed to protect its fast growing monopolistic business from competition. As this new business gains momentum and starts breaking out, our research indicates that not only is it well positioned in the industry, but it should also increase profitability. Therefore, we believe that the underlying growth should be faster than the current Wall Street forecasts for it seem to indicate.

A strong balance sheet

RadiSys has a market cap value around 100 million, and a balance sheet with 45 million in cash and about 45 million of debt, as most of its cash was used to buy Continuous Computing. While this cash to debt ratio is okay, the current value of both operations is about the same value as its purchase of Continuous Computing for $119 million in stock and cash about a year ago. Therefore, as a result of current market conditions, investors can now buy both companies together for less than what RadiSys appears to have paid for Continuous Computing alone. In addition to their business enterprise, RadiSys owns about 5 acres of land next to their business campus, giving them several million dollars in additional, less visible assets.

A low valuation

RadiSys is one of the lowest valued companies that we can identify having the potential for such high growth, especially in the mobile computing space. It is extremely unusual to find a company at such low valuation that is building a value added eco-system and growing both vertically and horizontally in such a high growth market as embedded mobile computing. Their market leadership has attracted best-in-class partners from a variety of industry segments to join its ecosystem in solutions, hardware, silicon and services. The Silicon segment alone boasts such recognized partners as:

Broadcom (BRCM)
Freescale Semiconductor (FSL)
Intel (INTC)
Mindspeed (MSPD)
Qualcomm (QCOM)
Texas Instruments (TXN)

The potential we see in RadiSys bears similarities to our earlier findings in WestPort Innovations (WPRT). When its stock was being hammered by the market, our review and assessment of its monopolistic business potential focused on its revenue growth, the increasing velocity of new companies actively contracting with Westport, and the horizontal expansion of the natural gas engine industry. For comparisons, we strongly recommend Westport (WPRT) has big engine power to grow.

Is the enterprise building value for their shareholders?

The company's last quarter financial report, although not robust, was okay. However, the signal that Wall Street responded to was a continued weakness with many of its regular clients. The completed quarter had about a 2 million decline in revenues, but the gross margin increased a strong 4.6 percentage points. It appears that RadiSys is still driving down their cost structure all the way across the board, which is welcome news. However, investors should be aware that the forecast for the current quarter's software sales, the highest margin category, is also down, partly a result of European based sales softness.

Is this a good business?

The new business model is a very good business, and better yet, the company seems to have strong leadership in a very tough to build industry. Its embedded mobile business leans towards being nearly monopolistic, as there is very high cost associated with changing already established solutions, which creates very large barriers to entry. Consequently, it has few global competitors, and in short, the business has very solid value.

New management, along with the combination of its next generation product and a well placed purchase, gave the company the ability to morph into a new high growth company with expanding margins while also substantially reducing costs. In the 2nd quarter results, it had 24 new designs wins across 21 different customers, 9 of which were new to RadiSys and indicative of a much needed increase in clientele. In its first year as a combined company, it achieved 91 design wins with a total value of over $300 million in revenues over the next 5 years. That gives it roughly a 1:1 backlog over 5 years with higher margins. Even with legacy products falling off and the recent economic downturn, the business appears to be changing from a waning, low margin, legacy business into a more dynamic, potentially high growth company.

Smartphones M2M (Machine to Machine) is predicted by UMTS Forum to have overall growth topping 33% annually for the next four years for cellular modules. That is one of the higher growth markets forecast that we have seen, and perhaps some of RadiSys many design wins will filter into this highly explosive field. Profit margins for own next generation product have a 40-50% margin, up from about 30% for its legacy products. This explains why margins are improving significantly, even though revenues were flat.

Where's the train wreck, and is the fog from the wreck clearing?

When finding companies with a lower enterprise valuation, often a "train wreck" happened that drove the value down, sometimes close to cash. We have identified 3 major issues that have pushed or kept the value so low:

1. Poor 5 year growth record.
2. Large decline in legacy sales.
3. Rough execution.

1. RadiSys still has not proven to investors that this is a real turnaround, and based on its past performance and the recent stock action, it looks like a poor bet. With that said, part of the attractiveness to us is its very low valuation.

2. The decline of core legacy division sales of 60% is large. The good news is this division is now such a small percentage of overall revenues, it should be considered a non-core business that will statistically have minimal impact to the overall business going forward.

3. RadiSys has had a hard time executing, but this is not uncommon when acquiring and/or implementing new business plans. Based on other experiences, we believe it will typically take about two years to achieve operational effectiveness and build momentum. With that said, we expect it may take this company another year to gain significant traction and a premium valuation.

A Notable Sales Valuation Ratio

RadiSys has sales of $330 million. A market capitalization of $100 million would give a price to sales ratio of less than 1:3, or about 30 cents valuation for every dollar of sales. This is one of the lowest price to sales ratios that I ever recall seeing in a high growth field with a robust ecosystem. In the chart below, we compare this low RadiSys price to sales ratio with the publicly traded partner companies mentioned earlier. To achieve parity with the next lowest partner within their silicon services ecosystem, the stock would need to more than double.

Company

Price to Sales Ratio

RadiSys

.30

Freescale Semiconductor

.70

Intel

2.47

Mindspeed

.80

Qualcomm

5.75

Texas Instruments

2.54

In Summary

We enjoy companies that can provide outstanding execution - turning weaknesses into real strengths. Along with bringing down costs and substantially increase cash flow, management has endeavored to greatly enhance the company's growth prospects and the business model with many new high growth solutions to drive future success. Furthermore, we see RadiSys as possibly having certain monopolistic type advantages, and see it as currently being significantly undervalued.

Disclosure: Durig Capital and certain clients or client related accounts are long RSYS. At the time of submission for publication, the stock price was $3.48/share.

Please note that all yield and price indications are shown from the time of our research. Our reports are never an offer to buy or sell any security. We are not a broker/dealer, and reports are intended primarily for distribution to our clients. We frequently obtain better yield/price executions for our clients than is initially indicated in our reports.

Source: RadiSys Finds A Niche With Embedded Wireless Infrastructure Solutions