NTCT - NetScout: 5G And AI May Imply Undervaluation

Summary

• NetScout provides digital security systems so that clients can protect their online businesses against possible disruptions.
• I would highlight the recent increase in revenue in the United States. Quarterly revenue increased by 11% q/q.
• The development of 5G networks will likely increase the number of potential clients.

NetScout Systems, Inc. (NTCT) expects to benefit from necessary digital transformation of clients in many sectors. I believe that the development of new 5G networks will likely bring new opportunities for new actors, which may need digital security systems like those of NTCT. Besides, in my view, further reduction in the debt, new products, and the application of artificial intelligence for data analysis could bring significant business growth.

NetScout: In The Last Quarterly Report, Revenue From The United States Increased By 11%

With more than thirty years of experience in its field, NetScout is a company that provides digital security systems so that companies can protect their online businesses against possible disruptions. Among its clients we can find different service providers, small and large companies, and local, state and federal government agencies.

According to the last annual report , NetScout has almost 3,000 employees, distributed in 35 countries around the world, 65% of which are located in the United States.

In the last quarterly report, 67% of the total amount of sales came from the United States, 13% came from Europe, and the rest came from Asia and other parts of the world. I believe that the business model is geographically diversified. I would highlight the recent increase in revenue in the United States. Quarterly revenue increased by 11% q/q.

NetScout divides its activities according to the market in which its clients' activities take place. These are the business market in general, the telecommunications market, and the government agency market, whether local or federal. For all these clients, different types of services apply in terms of their products and functions. For governments, both in the United States and internationally, they offer advice and support in the area of ??security and the application of artificial intelligence for data analysis and other functions.

Regarding the service for companies in general and the telecommunications market, NetScout provides a series of packaged services, which include the administration and management of connectivity networks, database management and its transformation to cloud storage, and the optimization of the performance of digital channels.

Balance Sheet: NetScout Reduced Its Debt, Which Could Bring EV/EBIT And EV/EBITDA Expansion

We observed a significant drop in cash and cash equivalents. As of December 31, 2022, cash was equal to $352.044 million with marketable securities of $57.262 million. Besides, accounts receivable were equal to $215.838 million with inventories of $18.621 million and prepaid income taxes of $8.780 million. Finally, total current assets were $681.947 million.

Fixed assets were equal to $37.590 million with operating lease rights of use assets of $51 million, goodwill worth $1.72 billion, and intangible assets of $382.257 million. Finally, total assets stood at $2.904 billion.

NetScout's liabilities included accrued payable worth $15.451 million together with accrued compensation of $72.259 million, deferred revenue of $317 million, and current portion of operating lease liabilities of $10 million. Total current liabilities stood at $440.009 million.

With deferred tax liability of $40.119 million and accrued long term retirement benefits of $34.182 million, the long term deferred revenue stood at $127.513 million. Finally, with operating lease liability of $49.582 million, long term debt stood at $200 million with total liabilities worth $898.959 million. In my view, the decline in cash seen in 2022 was due to a payment of tax liabilities and a significant reduction in long-term debt.

In my view, further reductions in the long term debt will likely enhance the company's financial position, which would bring the attention of more investors. As a result, I would be expecting an increase in the EV/EBIT ratio and the EV/EBITDA ratio.

Revenue Catalysts Include Digital Transformation, 5G, New Products, And Inorganic Growth

I believe that revenue growth can be expected for several reasons. First of all, if NetScout continues to successfully offer a 24-hour quality support service to immediately solve any type of problem that a client may have, such as a poor connection speed or a cybersecurity problem, more clients will likely join the company.

Some other factors that will likely enhance growth are the digital transformation of recent times in consumers, service providers, and production companies. Besides, the recent evolution of 5G favors NetScout's sales growth since more clients are potential contractors of Netscout's service. Let's keep in mind that they require advice or support in different areas as well as specialized personnel to resolve conflicts that may arise.

I also believe that innovation in the development of its new products, deepening of the relationships with existing clients as well as the expansion towards new fields of clients and adjacent service agencies will likely enhance growth.

Finally, in my view, locating potential value acquisitions for the growth of the company is always an option. Let's keep in mind that the company acquired other targets in the past. Management appears to have expertise in the M&A markets.

Income Statement Modeling

My simplistic income statement model included 2033 product revenue of $863 million with service revenue of $937.615 million. Total cost of revenue would be -$450.830 million with research and development close to -$360.205 million. Besides, 2033 sales and marketing would stand at -$556.083 million with general and administrative expenses of -$205.627 million and income from operations of $102.367 million. Let's note that my number for the years 2023 and 2024 are not far from the expectations of other financial analysts.

Cash Flow Modeling

I studied carefully the company's cash flow statement reported in the last quarterly report, and made several assumptions about the future cash flow. In the nine months ended December 2022, the company reported net income of $62.869 million, depreciation and amortization of $64.302 million, and operating lease rights of use assets of $7.984 million.

Share based compensation expense was $47.225 million with deferred income tax of -$38.435 million, changes in accounts receivables of -$67.101 million, changes in inventories of $8.323 million, and prepaid expenses worth $4.279 million. Also, with changes in accounts payable of -$7.129 million, accrued compensation of -$7.804 million, and deferred revenue of -$18.910 million, I obtained CFO of $43.923 million.

I used a forecast until 2033 because NetScout reported massive revenue growth in the past. In this case, I believe that it is fair to discount FCFs from now until 2033.

I obtained 2033 net income of $95.407 million together with a depreciation and amortization of $216.685 million, operating lease right of use assets of $23.283 million, and 2033 share based compensation of $108.193 million.

Besides, 2033 deferred income taxes would stand at -$28.687 million with changes in accounts receivable of $18.385 million, changes in inventories of -$18.089 million, and changes in prepaid expenses of close to -$4.104 million. 2033 Accrued compensation would stand at $5.409 million with changes in operating lease liabilities of -$27.282 million. Finally, 2033 net cash provided by operating activities would stand at $391 million.

I believe that the market is expecting significant sales growth and further EBIT margin expansion in the coming years. NetScout currently trades at an EV/ TTM EBIT close to 28.62x. I assumed that debt repayment could push the company's EV/EBIT ratio even higher.

With capex close to -$13 million, 2033 FCF would stand at around $378 million with a NPV of $1.65 billion. My CAPM model would include a beta of 0.9 and a WACC close to 9.80%.

I also obtained a terminal value of $3.5 billion and a net present value of $1.25 billion. Finally, the enterprise value would result in close to $2.95 billion with an equity valuation close to $2.75 billion. The fair price would be around $39.5 per share.

Risks And Competitors

NetScout operates in a highly competitive market. Besides, competitors are companies with greater recognition and a larger available budget, which would also lead them to respond more effectively to new changes and adaptations necessary for survival in the market. Some of the companies that compete with NetScout are Cisco Systems ( CSCO ), Ericsson ( ERIC ), Dell Systems ( DELL ), Nokia ( NOK ), Huawei, Cloudflare ( NET ), and IBM ( IBM ) among others.

Due to the changing environment in which NetScout operates, it has risks for its business in terms of competition and the possibility of adapting to a possible problem arising from a complication in its services. Added to this, NetScout depends more and more on contractor companies, so any conflict in the services they provide could compromise the company's activities.

NetScout's reputation may be compromised due to vulnerabilities or security defects in the products or services offered to clients. As a result, the company's brand may lose value, which may drive NetScout's share price down.

The products and services we sell to customers, and our cloud-based solutions, may contain vulnerabilities or critical security defects which have not been identified or remedied. We may also make prioritization decisions in determining which vulnerabilities or security defects to fix, and the timing of these fixes, which could result in an exploit that compromises security. Source: 10-k

Finally, if NetScout fails to assess new technological trends, or new products don't find sufficient demand, the company's revenue growth and FCF will likely decline. NetScout discussed these risks in a recent annual report.

Our success is dependent upon our ability to meet our customers' needs, which are driven by changes in technologies, new application technologies, new security risks and the emergence of new industry standards. In addition, new technologies may shorten the life cycle for our products and solutions or could render our existing or planned products and services less competitive or obsolete. We must address demand from our customers for advancements in our products and services applications to support our customers' growing needs and requirements. Source: 10-k

Conclusion

NetScout is benefiting from the need for digital transformation of clients in many industries, and the development of 5G networks will likely increase the number of potential clients. I also appreciate that NetScout recently reduced its debt outstanding, and has a substantial amount of cash to develop new products as well as to invest in sales and marketing or M&A operations. In my view, further increase in CFO will likely imply larger stock valuations. Hence, I believe that there is still upside potential in NetScout's stock price.

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