CMBM - Extreme Networks: Strong Growth And Good Leadership Make It A Buy

2023-04-06 18:56:41 ET

Summary

• Extreme Networks, Inc. has proven the ability to sustain revenue growth in the high single-digits.
• Extreme Networks trades at just above 2x EV/Sales, which is clearly justified by their margin profile and growth prospects.
• Low debt and share buybacks are a huge positive here.
• Management at Extreme Networks, Inc. is well-liked by employees and is clearly effective.

Extreme Networks, Inc. (EXTR) provides networking software, hardware, services, and maintenance contracts to its customers. These clients typically work in the IoT cloud space. EXTR has a market capitalization of $2.31B and an enterprise value of $2.4B. They compete with many large players like Cisco Systems, Inc. (CSCO) and Juniper Networks, Inc. (JNPR) but have carved out a nice niche for themselves.

Revenue

Outside of a minor contraction in 2020, Extreme has shown significant revenue growth, including growing more than 10% in 2022. Extreme is in a space with clear tailwinds and revenue is expected to continue the momentum.

The chart above shows that beautiful 45-degree upward angle in the revenue curve, which is a prerequisite for a buy recommendation from me. This is indicative of a company that knows how to expand their customer and product base year after year in an effective manner.

Valuation

EXTR looks slightly expensive compared to peers, trading at 2.1 EV/Sales. Some notable comps include Infinera Corporation ( INFN ) (trading at 1.4x), Inseego ( INSG ) (trading at .88x) and Cambium Networks Corporation ( CMBM ) (trading at 1.53x). Although EXTR is trading at a premium to many peers, it is understandable given their runway for growth from $1.2B in LTM revenue.

The company is also pushing to shift much of its revenue to a subscription-based model. As this transformation happens, margins will expand, and this should be a solid driver of improved earnings. The subscription model has been a proven winner for many companies and will hopefully help EXTR push its revenue to ever greater heights.

Given its positioning in the space, potential for revenue growth, and the items we'll discuss in the rest of the article, the Extreme Networks, Inc. valuation actually seems justified and perfectly acceptable.

Debt

Extreme has just $300M of debt on the balance sheet , with $223M of this being long term. Given that they have more than $200M in unencumbered cash, net debt is only $100M. Compare that against a quarterly revenue of over $300M and it becomes very clear that debt isn't an issue for EXTR. Being in the high interest rate environment that we currently find ourselves, this is an excellent situation to be in.

In fact, they have a very large amount of headroom to take on more debt and expand if needed. I'd like to see that happen in the future if, of course, the expansion makes sense. Either way, the balance sheet is quite healthy and debt service is negligible.

Dividends

Extreme Networks, Inc. has never paid dividends and I do not expect them to start given the growth prospects of the company. They've also made no mention of starting dividends that I can see. Of course, I love to see dividends in the stocks that I recommend, but they don't all pay them, especially in the tech space.

Shares Outstanding

Shares outstanding have jumped about 30% over the last 7 years, from 100M to 130M. This is not uncommon in the space. Companies issue shares to raise capital for expansion. The question about share issues is if the money is used wisely to deliver back more value in share price than was removed by diluting the pool.

Now we've come up from ~$3 a share, to ~$18 a share currently, giving us a share price return of 6x, versus that small dilution to the share pool. With that in mind, the issuance of shares is perfectly reasonable and provides a fantastic return. Especially when you factor in the low debt, and the fact they won't pay interest on shares.

Extreme Networks, Inc. approved a share repurchase plan for $200M in May of 2022. It is clear that management has been prudent and takes capital allocation seriously. Hopefully, they'll start to repurchase these shares in the near future as their overall revenue rises.

Mergers and Acquisitions

Given some of the other players in this space, there is always a chance that Extreme Networks, Inc. could be a takeover target. There have been rumors in the past, but nothing is imminent. It is nice to have a buyout as a potential catalyst, but there is nothing material enough here to make it a core part of my thesis.

Leadership

CEO Ed Meyercord is well versed in this space, having served on the Board of Directors at Extreme for 6 years before joining as CEO in 2015. It is clear that his knowledge of the industry has helped the company grow, and this is reflected when we examine employee morale.

I find that what the employees say about their leadership to be incredibly instructive. With over 500 reviews on Glassdoor, 93% of Extreme's employees approve of their CEO and 80% of Extreme employees would recommend working at the company to a friend. Having an engaged and satisfied employee base adds to the bull case at EXTR.

Conclusion

While Extreme Networks, Inc. has a high valuation, it is justified. I consider this stock to be a reasonable buy. The EV/Sales sits above many peers, but that is not surprising given that the growth rate at Extreme Networks exceeds that of the larger players. Extreme has carved out a niche with satisfied customers and is pushing for a shift to a recurring revenue model with subscription payments.

The larger players like Cisco and Juniper have not been able to kill them, and EXTR is chugging ahead with projected revenue growth. With organic growth as well as a shift in the earnings mix (recurring revenue has grown YoY consistently), the outlook is bullish.

Extreme Networks, Inc. margins should expand nicely over the coming years, and that lift to earnings is enough to make taking a position in this stock reasonable, especially if you want exposure to the IT sector while avoiding some of the sleepy incumbents.

I've got to give this one an overall rating of buy.

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