AVNW - Aviat Networks: Attractive NEC Transaction Is Priced In

2023-11-01 04:17:28 ET

Summary

• Aviat Networks has found success in the network solutions market, achieving profitability and organic growth after poor long-term financials.
• The company's wireless connectivity through microwaves offers a competitive advantage with lower operating costs for customers.
• Aviat's recent acquisition of NEC's wireless transport business is expected to generate additional revenues and create value for shareholders, as the acquisition was done very cheaply.
• Still, the stock seems to be priced correctly, as my DCF model estimates a slight overvaluation when excluding the NEC transaction.

Aviat Networks ( AVNW ) manufactures wireless solutions. After turbulent long-term financials, Aviat seems to have found its niche in the network solutions market. The company has achieved a fairly good level of profitability in recent years along with a good amount of organic growth. The company also seems to trade at a low valuation as the company’s current forward P/E stands at 7.2. Still, my DCF model estimates that the stock isn’t undervalued with estimates that I see as appropriate.

The Company & Stock

Aviat has a range of wireless access and transport solutions. The company sells products such as wireless transporters, network routers and access, and AviatCloud SaaS software that helps in monitoring as well as other parts of operating networks. In addition, the company sells services relating to the products for customers. Of Aviat’s revenues, 58% come from North America, with the rest coming from a wide geographic footprint.

The company’s offering differs from competitors in a significant way. The company’s core product enables wireless connectivity through microwaves. Aviat’s offering is competitive in the fact that maintaining the network requires a significantly lower amount of OPEX as opposed to most competitors. As opposed to fiber connectivity, microwave wave connectivity is faster and cheaper to implement.

Aviat’s offering suits many public institutions and industrial use cases. The company’s core markets include state and local governments, public safety institutions such as fire stations and police departments, utilities such as gas, water, and electric utilities, and industrial customers. As the offering is easy and quite cheap to install and operate, Aviat is competitive in rural markets.

As Aviat has achieved a good level in operations only recently, the company hasn’t yet started to pay out dividends . Yet, the company’s stock has returned a good return from 2020 forward as the stock rallied significantly in 2020 and early 2021:

Acquisition of NEC’s Wireless Transport Business

In May, Aviat announced that the company has entered into an agreement with NEC to buy the company’s wireless transport business for a total valuation of $70 million in cash and shares. The acquisition seems to create a significant amount of value for Aviat’s shareholders; the company expects the acquisition to generate $150 million in additional revenues with an EBITDA margin of 11-13% achieved by the end of the second year after the transaction – the price of the acquisition corresponds to an EV/EBITDA of around 3.9.

Financials

Aviat’s long-term revenue trends have been quite turbulent. The company’s revenues grew very fast from FY2004 to FY2008, but after the year, revenues began to decline. Aviat’s revenues reached a bottom in FY2020 with revenues of $239 million. From FY2017, when the company’s revenue level started to stabilize, to FY2023, Aviat’s compounded annual growth rate has been 6.2%:

Aviat is guiding for revenues between $367 million and $374 million in FY2024, with the middle point of the guidance corresponding to a growth of 6.9%. The company’s wireless solutions seem to have a good amount of demand. Most recently, Aviat won a $50 million contract from the U.S State Government in September, including a good amount of Aviat’s offerings in the bid.

As Aviat has had some difficulties in keeping up a competitive offering in the long term, the company’s EBIT margin has been turbulent and mostly poor. From FY2004 to FY2016, Aviat’s average EBIT margin was a negative -3.1%. Since, the company has been able to pull itself into profitable territory with sequential increases in the margin – in FY2023, Aviat’s EBIT margin was 8.5%:

Valuation

As Aviat started to realize a good level in profitability in FY2021, Aviat’s forward P/E started to rise along with the stock into a high of 25.0 in early 2021. After the peak, Aviat’s forward P/E has been falling into the current ratio of 7.2:

To analyse the valuation more thoroughly, I constructed a discounted cash flow model in my usual manner. The model doesn’t factor in the acquired NEC business. In the model, I estimate Aviat to hit the upper range of its FY2024 guidance in revenues with an estimated growth of 7.5%. After the year, I estimate Aviat’s growth to start slowing down in steps. Aviat’s growth slows down into a perpetual growth rate of 2% from FY2033 forward. In total, the estimated revenues represent a CAGR of 4.6% from FY2023 to FY2033.

For Aviat’s margins, I estimate some further operating leverage after the company has successfully scaled its margins from FY2019 to FY2023. In the model, I estimate the FY2024 EBIT margin to be 9.7%, around 1.2 percentage points above the achieved FY2023 level of 8.5%. After the year, I still estimate slight increases in the margin, as the model includes an EBIT margin estimate of 10.8% from FY2027 forward.

The mentioned estimates along with a cost of capital of 14.87% craft the following DCF model with a fair value estimate of $24.23, around 7% below the price at the time of writing:

The used weighed average cost of capital is derived from a capital asset pricing model:

As of the time of writing, Aviat doesn’t hold any interest-bearing debt as the company prides itself on keeping a strong balance sheet. In the CAPM, I estimate the debt-to-equity ratio stay at 0%, as I don’t see a change in the financing as very likely. On the cost of equity side, I use the United States’ 10-year bond yield of 4.85% as the risk-free rate. The equity risk premium of 5.91% is Professor Aswath Damodaran’s latest estimate for the United States, made in July. Yahoo Finance estimates Aviat’s beta at a figure of 1.61 . Finally, I add a liquidity premium of 0.5%, crafting a cost of equity and a WACC of 14.87%, used in the DCF model.

Closing Remarks

At the moment, I don’t see Aviat’s current price as too good of an entry point. The company has been able turn its operations around with an offering that differs from the competition. The stock also currently trades at a very low forward P/E of 7.2. Still, the stock doesn’t seem to have a very good risk-to-reward as my DCF model estimates the stock to be very slightly overvalued. The DCF model doesn’t factor in the acquisition of NEC’s wireless transport business, though – as the acquisition is to be done with an attractive valuation, I believe that it negates the slight overvaluation estimated in the DCF model. For the time being, I have a hold rating for the stock.

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