CALX - Calix: Promising Company But Remain Cautious For Now

2023-10-09 03:08:29 ET

Summary

• Calix has a strong position in the market through its focus on network service levels and managed services.
• CALX is reshaping the broadband market with its service-oriented approach, streamlining infrastructure and offering higher levels of customer satisfaction.
• I am seeking a more proven track record of maintaining strong growth during economic downturns and consistent cash generation to become bullish.

Investment Thesis

I think Calix, Inc. ( CALX ) has a unique opportunity for growth due to its strong position in the market, driven by its focus on network service levels and managed services through its Platform-based approach. Calix has been a trailblazer in changing the traditional broadband network infrastructure with a service-based approach. However, despite my optimism and positive outlook for the company's growth, the macro environment, coupled with the stock's valuation, keeps me more cautious at the moment.

2Q23 Review and Outlook

Calix reported strong performance in the second quarter of 2023, with both revenue and gross margins aligning with or reaching the higher end of the guidance. This marked the ninth consecutive quarter of revenue expansion and the fourth consecutive quarter of sequential growth in gross margins. The company's management pointed out that customer adoption of (Revenue / Intelligent) EDGE and Cloud offerings continued to grow steadily, reaching 1,008 and 885 in the second quarter of 2023, compared to 988 and 865 in the first quarter of 2023. Additionally, the growth in Managed Services reached 349, up from 334 in the first quarter of 2023 and 270 from a year ago. Furthermore, the expansion of software, coupled with changes in product mix and reduced fees for components, contributed positively to the gross margins. This resulted in Calix reporting a significant increase in gross margins, which exceeded expectations.

However, despite these positive developments in terms of strong execution, sequential revenue growth, and robust margins, Calix acknowledged that its overall growth rate for 2023 is expected to be slower compared to 2022 and 2021. This slowdown is primarily attributed to challenges related to medium-sized customers working through their inventory, which is also causing a shift in the product mix from Revenue Edge to Intelligent Edge. Nonetheless, Calix's updated annual revenue growth guidance of over 20% in the face of a challenging economic environment remains relatively strong despite these challenges. The continued sequential growth reinforces to investors the company's ability to secure and expand its customer base, particularly with its BSP (Broadband Service Provider) customers, providing a sense of predictability and visibility in terms of future revenue growth.

Shaping the Future of Broadband through Service-Oriented Approach

Calix is at the forefront of the revolution in the traditional broadband infrastructure by simplifying the hardware platform that underpins the physical layer. The company's emphasis is on creating a versatile platform capable of delivering various capabilities while remaining adaptable to different use cases. Calix's innovative platform approach is streamlining infrastructure for customers by reducing the need for specialized, proprietary appliances that have traditionally dominated the network. Transitioning to this platform-based model allows for greater flexibility through software, accommodating multiple use cases and facilitating Calix's software-layer innovations.

Calix Reshaping the Broadband Market with Networks and Services

Calix is revolutionizing the way broadband networks operate, drawing parallels to the shift seen in other hardware industries away from complex proprietary hardware. The company is standardizing network infrastructure to help customers transition to platforms like AXOS and EXOS, where the software layer plays a key role in providing network visibility. This software-defined approach enhances visibility into both the network itself and individual subscribers. As a result, broadband service providers can offer higher levels of customer satisfaction and have the opportunity to generate more revenue from subscribers over the long term. Calix's approach to broadband is poised to transform the industry from a utility-like model focused on speed and price competition into one that prioritizes a wide range of services.

Valuation

I see substantial growth potential for Calix, thanks to the strong competitive advantages it has built with its network service platforms and managed services. Calix is at the forefront of transforming traditional broadband network infrastructure by emphasizing a service-oriented approach, and there are no apparent competitors following a similar path in the broadband services sector. However, despite my optimism and positive outlook for the company's growth, there are both broader economic factors and company-specific considerations that make us cautious about being more bullish on the stock at its current valuation.

The stock is trading at a forward PE of 31x compared to a sector median of 21x. The higher multiple can be justified by the company's long-term revenue growth expectations in the 20%+ range, which puts Calix in the top tier of Networking companies along with Arista, which also has historically delivered growth in the top-tier of Networking companies. However, from current levels, I see limited chances of upward multiple re-rating, which is why I assign a hold rating to the stock. I recommend waiting for a better entry for long-term investors.

Investment Risks

The weakening macroeconomic conditions are causing Tier 2 and Tier 3 service providers to reconsider their investments. Calix's growth has been driven by these providers gaining market share over Tier 1 service providers. However, the economic downturn may impact investments from Tier 2 and Tier 3 providers. Moreover, while Calix offers a superior platform for service providers to deploy their services, these providers may initially explore in-house solutions to maintain control over subscriber data sharing. If more service providers choose in-house solutions, it could pose challenges for Calix's potential market.

Conclusion

I currently assign a hold rating to CALX. Despite the company's strong potential to lead its category and create new revenue opportunities by disrupting the traditional broadband services market, I am looking for a more established track record of maintaining robust growth during economic slowdowns and a consistent ability to generate cash. My concern in the short term stems from the fact that Calix's current stock price trades at a high multiple of 31x times the next twelve months, a substantial premium to the sector media. Hence, I recommend potential investors to wait for a better entry point at the moment.

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