Ubiquiti Networks (NASDAQ:UBNT) provides service providers and enterprises with networking gear for fixed wireless broadband, wireless backhaul, routing, enterprise WiFi, video surveillance, and machine to machine communication components. The company brings broadband access to the un-connected regions of the world, especially in emerging markets and rural areas. It delivers high network performance at disruptive prices, where traditional high-touch, high-cost solutions are too expensive and not easily scalable.
The business model is driven by 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 product development and product improvement. The community nurtures direct communication, accelerated product adoption, and quick time to market. Embedded in the model is technological leadership and products with disrupting price-performance characteristics that address customers' most critical features, without costly high-touch relationship fringe features.
Leveraging the information access of the Internet allows customers worldwide to achieve the features and functionalities that are critical to their requirements. The community is cost efficient and highly-scalable, and functions as a self-sustaining eco-system for product feedback and innovation, product support, information dissemination, and sale origination. It assumes the role of a sales force for Ubiquiti and in fact allows the company to function without one. The model by-passes the traditional roles in sales development, marketing, and product support; and in so doing eliminates legacy inefficiencies in favor of a value-driven cost-effective and scalable model. The driving force behind the model is Robert Pera, Founder and CEO, a self-styled product CEO, who runs R&D and is the lead recruiter of technical staff in the company.
Financially the model exhibits rapid revenue growth, a competitive cost structure enabled by the role of the community and contracted manufacturing, robust R&D, strong operating margins (33% - 34%), low capital expenditures, and high ROIC.
Substantial resources are devoted to R&D. 111 full-time-employees were in R&D, or 61% of 183, total personnel employed in the company (as of 6/30/13). Robert Pera, CEO, and engineer by education and vocation, leads first-hand the recruitment of engineers worldwide. Pera is pragmatic in his particular focus; seeking, recruiting and retaining knowledgeable R&D personnel, wherever is available. Ubiquiti's R&D professionals are located in California, Illinois, New York, Lithuania, Taiwan and Russia. R&D emphasizes small teams, a flat reporting structure, and identifiable contributions. As indicated in Pera's blog, he focuses on retaining "walkers", who contribute to positive value and have the potential of making phenomenal contributions and becoming "superstars". He dismisses "talkers", who contribute negatively to the company.
Products and solutions benefit from the active engagement between the community and the company's R&D personnel throughout the product development cycle, resulting in rapid introduction and adoption of new products. R&D personnel evaluate the input from the community and respond to their needs, modifying products and developing new products based on the input received. Products and solutions are designed to reduce complexity in installation, facilitate the expansion of wireless networks, and enable high product performance at highly disruptive prices. Manufacturing, logistics, and warehousing, is contracted with third parties in China.
Progress and growth under CEO Pera have been nothing short of spectacular. Pera holds a Bachelor and Master of Science degrees in Electrical Engineering. In 2005 Pera left his Hardware Engineer job in Apple to dedicate himself full-time to Ubiquiti. He set up a $650 a month business office that doubled-up as Pera's home. Bootstrap operations had no supporting infrastructure; no advisor, or a board, or lawyers, or accounting support. An upfront customer provided advance payment to fund first manufacturing and shipment. IPO was in October, 2011.
Fast forward from early days. In fiscal year 2008 revenues were $22.4 million, $320.8 in 2013, and expected to reach $568.0 million in 2014. Products are sold in over 50 countries to service providers and enterprises mostly through over 100 distributors, and also original equipment manufacturers and enterprises. Some 2,300 distributors and interested parties worldwide have been trained in Ubiquiti products and solutions.
Product innovation and speed to market are strategic priorities directed to addressing the needs of service providers and enterprises worldwide. They are the engine enabling revenue growth.
Products for service providers (over 80% of revenues):
- airMax, by far the most important contributor to revenues (over 60%), was introduced in September, 2009. It enables wireless networking for video, voice and data. airMax is able to support wireless network traffic for hundreds of clients per base station over long distances while maintaining low latency and high throughput.
- EdgeMAX, networking routing platform, was introduced in September, 2012.
- airFiber, point-to-point wireless backhaul, was introduced in March, 2012.
Enterprise products (shy of 20% of revenues):
- UniFi, enterprise WLAN, introduced in January, 2011, allows WLAN managers to configure and administer a UniFi network from any web browser.
- airVision, video surveillance, introduced in August, 2011, allows management of camera and recording devices from any web browser.
- mFi, machine to machine communication, introduced in June, 2012, allows devices to be monitored and controlled remotely (building temperature, power consumption) via WiFi, from any web browser.
CEO Pera's interest in the company aligns with the interest of shareholders at large. The proxy statement, dated October 28, 2013, shows that Pera owned 65.4% of the common stock. Further, the statement shows that Pera was the only executive with no equity awards, or unvested options, and with $1 in salary compensation in 2011, 2012 (and apparently 2013).
Underlying growth is the increase in the global use of the internet, the opportunity available in underserved markets including in emerging markets, the competitive advantage due to comparatively higher investment requirements and long lead time associated with building infrastructure for wired networks, and the company's product competitive advantages including price-performance. Industry sources estimate global internet traffic growth for the 2001-2016 period to run at close to 30% compounded annual growth rate. Meanwhile, aggregate end-user spending on wireless networking equipment for Enterprise WLAN, wireless broadband access, and LTE solutions, is expected to grow at a rate of 32% to $41.3 billion during 2012-2017.
Table 1 shows selected value metrics for the last three years, estimates for fiscal years 2014 and 2015, and the latest quarter's year over year comparison.
|Table 1. Ubiquiti Networks Value Metrics|
|(Amounts in millions of US$, unless otherwise noted)||FYE 6/11||FYE 6/12||FYE 6/13||3-Yr. Avg.||FYE 6/14 (NYSE:E)||FYE 6/15||Q3 2013||Q3 2014|
|NOPAT / Revenues||25%||29%||25%||20%||30%||29%||25%||31%|
|OC / Revenues||11%||13%||3%||9%||12%||12%||10%||12%|
|ROIC = NOPAT / OC||226%||225%||1005%||308%||246%||242%||254%||251%|
|EVA = (ROIC - WACC) OC||47.47||99.36||80.68||75.84||165.00||183.10||20.10||43.81|
|FCF (NOPAT - Inc. in OC)||n/a||79.65||119.65||99.65||110.00||182.00||36.13||5.88|
|FCF / Revenues||n/a||23%||37%||20%||19%||28%||43%||4%|
|R&D / Revenues||6%||5%||7%||6%||7%||6%|
|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|
- Three year average ROIC is 308%, well in excess of 10%, estimated weighted average cost of capital (OTC:OTC:WACC). Ubiquity creates substantial shareholder value by generating high ROIC with investors' capital costing 10%. High EVA relative to Operating Capital used is a corollary.
- Strong growth in revenues and in FCF, along with high ROIC, are complementary conditions in the creation of Enterprise Value and a strong stock price performance. Decrease in 2013 revenues was due to the counterfeit products (principally airMax platform) which preempted real-product sales, created uncertainty regarding product authenticity, and caused a buildup in the distributors' inventory.
- Reflective of the characteristics of the model are high NOPAT margins, low Operating Capital requirements, and high FCF generation.
- Sustained and growing investment in R&D drives product innovation, and growth in revenue and in FCF.
Business risk is discussed as the likelihood of FCF disruption due to an unfavorable event. In my opinion, management maintains risk-taking within the boundaries of knowledge in the broadband access business. Consider the following:
Operations Risk. NOPAT is subject to operations risk; the risk in the firm's commercial cycle (NOWC), which encompasses the company's day-to-day relationships with stakeholders and entails risks such as concentration with clients and suppliers and dependence on partners and resellers for performance; and geographic concentrations. Disruption in these relationships can upset the commercial cycle and negatively impact on NOPAT and on FCF. NOPAT is steady; NOPAT / Revenues ratio has averaged 20% in the last three years.
Ubiquiti relies on third party contractors for manufacturing, warehousing, and distribution; and on third party components and technology used in the company's products. The company also relies on relationships with distributors, which account for virtually the totality of annual revenues. The largest distributors can account for as high as 10%-20% of annual revenues. Distributors purchase products on a purchase order basis. They are not required to promote Ubiquiti products and are free to promote and sell competing products.
Revenues are geographically diversified; North America 26%, South America 21%, Europe, Middle East, Africa 40%, Asia Pacific 13%.
Financial Risk. Financial risk related to the use of debt ($72.4 million in 3/31/04) is minor relative to FCF available to service debt.
Other Risks. Notwithstanding moderate risk assessment, there is an abundance of risk events, other than those discussed, that can upset business. Natural catastrophes, or the loss of key managers, or technology theft, are examples of events that can disrupt business.
A track record free of major risk events does not preclude negative events from occurring in the future. This discussion does not cover all the conceivable risk events (internal, external, or macro-economic risks, or those with low-probability-high-impact) that could harm the business. Instead, the focus is in ascertaining that activities in the ordinary course of business are in line with Ubiquiti's business purpose and fall within management competence. In my opinion benefits, as measured by ROIC or NOPAT / Revenues, outweigh risks.
2014 and 2015
- Q3 2014 results showed a strong performance in revenues and NOPAT (Table 1). However, concerns arose over increases in Operating Capital (NYSE:OC) caused by a substantial inventory build (from $19.4 million in Q3 2013 to $66.0 million in Q3 2014) which impacted FCF negatively. Management explained (see Earnings Call) that inventory was built up strategically to prevent a repeat of shortages and delays in product delivery to distributors. Inventory was also built-up in anticipation of shipment for existing order backlog at the end of Q3 2014; and for new product inventory (including airFiber 5 and AirVision security cameras).
- Q4 2014 estimates call for marginal sequential increases in revenues and in operating income over Q3 2013.
- FY 6/14 estimates call for major improvement y-o-y, with revenues growing to $568.0 million (77% increase), and operating income increasing 104% to $196.0 million.
- Further improvement is expected in FY 6/15 with revenues reaching $656.0 million in revenues (15% increase), and $216.0 million in operating income (10% increase).
Below are two estimates of the stock's fundamental value along with the corresponding estimate inputs.
- $60.0/share value based on $182.0 million 2015 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.
- $62.0/share value based on $182.0 million 2015 FCF growing at 14% per annum through 2017, 10% in 2018, and 5% thereafter in perpetuity. WACC is as noted above.
- On May 29, 2014, the company announced its Board of Directors' approval to repurchase up to $75 million worth in common stock beginning on June 2, 2014. At that time the shares traded around $36.0/share. Currently the stock trades at between $39.0/share - $40.0/share.
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.