One Last Bite At Radcom Before 'NFV Mega Deployment' Kicks In

| About: Radcom Ltd. (RDCM)
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Radcom CEO Yaron Ravkaie guided to $20 million or more cash on the balance sheet by the second half of 2016. This implies $12 million FCF in the first half.

Mr. Ravkaie believes NFV service assurance is a winner-take-most market. With a groundbreaking Tier-1 deal in hand, Radcom is the clear leader in the market.

Analyst estimates appear far too low for Q1 and Q2 2016, setting the stage for positive surprises and earnings catalysts.

AT&T and Verizon announced ambitious 5G investment plans with trials starting in 2016. It remains to be seen how big this opportunity could be for Radcom.

Mobile World Congress is happening in Barcelona this week.

While market sentiment, especially in microcaps, remains incredibly negative, investors get one more shot to own Radcom (NASDAQ:RDCM) at a good price before their 'NFV mega-deployment' with a North American Tier-1 mobile operator kicks in and begins to show itself in the form of rapidly expanding revenue, earnings and cash flow in 2016. This is exactly the type of opportunity I look for: a microcap who has become a clear leader in a nascent but potentially very large and disruptive market, allowing for the possibility of large stock gains.

On the Q4 earnings call, Radcom CEO Yaron Ravkaie indicated that Radcom expects its cash balance to be north of $20 million by the second half of the year. Radcom entered 2016 with $8.7 million cash on hand. Consequently, Radcom should generate at least $12 million in free cash flow in the first half of the year. I'm not exactly sure what the payment terms are of the groundbreaking win disclosed on January 4, but revenue and earnings should dramatically expand in order to generate $12 million in FCF. By contrast, Netscout (NASDAQ:NTCT), Radcom's largest service assurance competitor (valued at $2 billion) generated $50 million FCF over its last three quarters. As I pointed out in a prior column, for Netscout to suggest the virtual probe deal it apparently lost to Radcom because it was too small appears patently false based on the free cash flow expected from the deal.

If we assume 80% gross margin and $4 million cash operating expenses per quarter (and no large upfront payments), it appears Radcom could generate ~$25 million revenue in the first half, far exceeding the lone analyst estimate at $5.8 million Q1 revenue and $6.8 million Q2 revenue. On the other hand, there could be some up front payments such that not all the cash is "earned" in the first half. Nonetheless, the lone analyst expectation for revenue in the first half ($12.5 million) is just slightly higher than $12 million of cash expected to accumulate on the balance sheet over the same time frame. To that end, Radcom appears set up to deliver meaningful upside earnings surprises when it reports earnings in April and July.

Expecting A Positive Newsflow in 2016

Coupled with the improving fundamentals of Radcom which features visibility for 3 years or more of revenue growth based on record backlog, the market for NFV and 5G investment by telecom carriers appears to be accelerating. Last weekend, the NY Times ran an insightful piece regarding AT&T's (NYSE:T) business and radical investment shift towards virtualizing its network to better compete with web scale players like Google (NASDAQ:GOOG) who are increasingly entering the telecommunications business with services like Project Fi. As web and telecommunication services begin to blur, this should accelerate operators to invest in technologies to help them compete against Google, Amazon (NASDAQ:AMZN), Facebook (NASDAQ:FB) and others.

Moreover, Verizon (NYSE:VZ) and AT&T have both made announcements indicating ambitious 5G rollouts (here and here) with trials expected to start with vendors like Radcom in the spring. I understand that 5G will largely be driven using software-defined networking and virtualized network functions which could provide yet another tailwind for Radcom's business as these carriers make critical investment decisions. In AT&T's rollout plan, the carrier indicates it plans to virtualize 30% of its network by the end of 2016, up from about 6% in 2015. In addition, numerous industry players, including Amdocs (NASDAQ:DOX) [a Radcom ecosystem partner] CEO Eli Gelman, believe Tier-1 operators will have largely made NFV investment decisions in the next 18 months.

To that end, I expect that Radcom's first Tier-1 anchor customer will order more MaveriQ in Q3 or Q4 as it appears this customer is aggressively moving on NFV implementation by being the first carrier in the world to deploy virtualized service assurance. Moreover, Radcom is set to begin trials with new potential anchor customers in Q2 which could lead to additional, mega NFV service assurance deals by year-end.

Putting it all together, there is a lot of good news that doesn't appear to be priced into the stock yet, including: low analyst estimates, and the potential for large, repeat orders from existing customers and new, Tier-1 anchor customers by year-end. When coupled with significant free cash flow generation expected in the first half, Radcom shares appear to offer investors are very asymmetric set up ahead of a potential flood of positive news.

Mobile World Congress commences in Barcelona this week, the telecommunication industry's most important trade show, and I'll be following the conference for any relevant NFV and/or 5G news.

Disclosure: I am/we are long RDCM.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.