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Clearfield’s 50x P/E Has It Trading At Least Double What It’s Worth

|Includes: Clearfield, Inc. (CLFD), COMM
Summary

Declining Revenues.

Loss and Stalling of Key Market Segments.

Ballooning Litigation Costs.

I don’t know of many telecommunication companies that trade at 50x P/E with declining revenue & earnings with projections for 2018 that offer little hope for a turnaround.  In fact, the company stated on its most recent earnings call that revenue would be flat for the first half of fiscal 2018 and maybe 5% for the entire year.  Couple this with the likelihood of dramatic increase in litigation expense with the patent fight with its main competitor Commscope; Clearfield is due for a serious pullback.  Let’s look at Clearfield’s challenges:  

Alternate Carrier  

Clearfield’s main source of growth over the past few years was based from its Alternate Carrier segment divided into three main channels, wireless, cable, and Google.  As discussed on Clearfield’s first ever earnings conference call on November 9, 2017, revenue from wireless and cable companies have stalled due to M&A activity and pull back from competitive pressures on Clearfield’s customers.  They claim this is due to Google’s massive pullback of resources and investment in Google Fiber. 

As per Clearfield’s CEO Cheryl Beranek, “M&A activity at major telco and cable providers has introduced distractions from their network builds. In addition, the lack of competitive build pressures, what many have dubbed the Google Effect, has slowed the rate of build and prompted wireline, cable and wireless providers to retract into a more thorough planning, rather than building phase for their fiber deployment programs.”

Google Fiber itself has lost three top executives in the past 12 months and has certainly curtailed launches in new and existing markets.  As discussed many times on Seeking Alpha, Clearfield was identified as an early vendor of Google Fiber and that relationship accounted for serious revenue gains for the company in years 2014 – 2015 that sent its stock from the single digits to the mid $20s.  But for whatever reason, Clearfield seems to have lost any momentum (and may be out as a supplier) with Google Fiber.  This is evident as Google Fiber recently launched two new markets (Louisville & San Antonio) and from Clearfield’s earnings report, you can easily extrapolate there is little to no revenue from Google Fiber as there had been in the past when Google Fiber launched new markets.   

Tier 1 

With revenue receding in its Alternate Carrier market and looking to find new growth opportunities, Clearfield made the decision to invest heavily in trying to break in the Tier 1 market.  They have spent the past two years investing in resources and spending the money to get required certifications of its products to be able to sell into this market segment.  This certification has been a learning process for Clearfield, as they have had to get their products done incrementally while they learn the certification systems.  To date, these expenses have been a drag on earnings and so far have had limited success, which has likely resulted in a few pilot projects.  In fact, Tier 1 revenue was down in their fiscal 4th Q.  It remains to be seen if Clearfield can crack this market against much larger, well-established players who will likely protect their turf with aggressive pricing and larger R&D departments.  Based on the company’s revenue outlook for 2018 of 5%, it does not appear that Tier 1 growth will have any significant impact until 2019.  One wonders if the Tier 1 customer base is waiting to see the outcome of the Commscope litigation case against Clearfield before committing any serious projects to them. 

Litigation

On Jan 31, 2017 Commscope filed a patent infringement case against case against the bulk of Clearfield’s product line.  Regardless of whether the strategy of Commscope was to slow Clearfield’s entry in to the Tier 1 marketplace, this will be a costly expense for Clearfield whether they prevail or not.  There are three likely outcomes for this case with varying degrees of financial and strategic exposure to Clearfield.  One, the case goes to court and Clearfield prevails.  Two, the case goes to court and Commscope prevails and Clearfield is forced to pay licensing fees or suspend selling its products.  Three, the case never goes to court and the two companies negotiate a cross licensing agreement of its products.  The 3rd outcome would likely cause Clearfield to lose any strategic selling advantage the company has.  All three outcomes will have significant, rising costs for the foreseeable future as discovery and depositions begin.  Outcomes two and three above could have significant impact to the business from a margin (licensing fees) or a complete reduction in any strategic product advantage the company has. 

Conclusion

Clearfield has many headwinds facing it for 2018 and even 2019. This would be challenging for a company that has a 15x or 20x P/E valuation, especially for one that has guided to 5% growth and 5% net income, ballooning litigation costs, and loss of revenue in its key market segments.  Why Clearfield currently trades at 50x P/E in a potentially frothy market is beyond me?   A more fair valuation would put the stock between $6-8. 

Disclosure: I am/we are short CLFD.