Equity Research Note (January 20, 2005)
Share:
Avocent Corporation (AVCT/OTC)
Solid quarter; Maintain Buy and $39 target
For complete note, follow this link:
http://needhamco.com/Research/Documents/200601120_AVCT_Solid_Quarter_-_Maintain_Buy.pdf
Disclosures applicable to this security (disclosure explanation on the last page of this report): B, G
Investment conclusion
Avocent dominates the keyboard / video / mouse market and enjoys great profitability. Their 4Q report was very solid, with 1Q revenue guidance at $96 - 102m versus consensus of $103m. Further, the recovery from 1Q's costly stumble is nearly complete. Given its market position and financial strength, we believe AVCT merits a premium multiple of 22x 2006 estimated EPS of $1.84, supporting a 12-month price target of $39.
Summary
o We believe AVCT is a compelling value coupling a 15x 2006 ex-cash EPS with a balance sheet featuring $346m or $7 per share of net cash. Our long-term growth rate is 13%, for a PEG of 1.2.
o We reiterate our Buy rating and 12-month price target of $39, based on EV of 22x estimated 2006 EPS. The 22x multiple reflects a 1.7 PEG using our long-term 13% earnings growth rate.
o EPS of $0.48 solidly beat consensus estimates of $0.43. Revenues of $106.8m met consensus. The bottom line was driven by 60.9% GM, above their long-term target of 58 - 60%. 1Q revenue guidance of $96 - 102m is well short of the $103m consensus.
o Avocent reported excellent cash-flow from operations of $19m in the quarter, aided by tightening R&D exponses which led to record 22.4% net margins. They repurchased a further 400k shares in the quarter for $11.6m ($29 per share).
o We believe the biggest risk is the potential competition from vendors of other technologies, including Intel, and server vendors Dell, HP, Sun, and IBM, threatening gross margin pressure. Further, the embedded business will cannibalize the higher priced appliance business.
Overview
Avocent reported the 4rd quarter slightly above estimates, with guidance behind consensus estimates for the 1st quarter.
AVCT: 4Q05 Needham Estimates vs. Actual ResultsSales increased 10% QoQ to 106.8m, led by digital product sales. European and Asian sales especially outperformed, as International sales now represent 44% of the total. Notably, embedded sales and software sales were up from $6.2m to 7m, which combined with digital's growth to drive margin record highs on a gross, operating, and net margin basis. The margin improvement reinforces our thesis that the products are differentiated and the KVM market acts more as a rational duopoly than a cut-throat competition - which again supports our argument for continuing high margins. Net income was nicely ahead of estimates, and combined with a lower share count (from 900k shares repurchased over the last 2 quarters) to record $0.48 in EPS, solidly beating our $0.42 estimate.
($mm unless otherwise indicated) Actual Estimate Actual vs. Estimate
Digital sales 58.8 58.6 0%
Analog & other sales 48.1 47.9 0%
Total revenues 106.8 106.5 0%
Gross margin (%) 60.9% 59.4% 150 bp
R&D 13.4 14.6 -9%
SG&A 23.3 22.3 4%
Operating margin (%) 26.6% 24.8% 183 bp
Net income 23.9 21.1 12%
Diluted shares outstanding (mm) 49.8 49.8 0%
EPS ($) 0.48 0.42 12%
Avocent's balance sheet metrics were strong, with inventory turns improving from 7.3 to 7.9. Accounts receivable again had less than 1% greater than 30 days past due. DSO jumped from 54 to 59, driven by a back-end loaded quarter. Note that our concern with back-end loading of quarters stems from management's desire to make Wall Street estimates, which typically necessitates selling at unusually attractive discounts, resulting in artificially shifting next quarter's sales into this quarter. Noting the record gross margins, we have none of thos concerns about Avocent in 4Q.
We are pleased that payables trended higher, from 40 to 51 days, as we expect Avocent to obtain outstanding payment terms given their clear success. The balance sheet remains rock-solid with $346m, no debt, and having generated $19m from operations in the quarter.
1Q revenue guidance came short of consensus estimates of $103m. Following a solid 3Q, forward revenue guidance was only slightly below consensus, leading to a precipitous drop in AVCT's stock. This time, with a much sharper forward revenue guidance gap to expectations, AVCT's stock jumped. While we don't believe that all the skeptics are gone, we believe Avocent is regaining Wall Street credibility 3 quarters solid quarters removed from the massive 1Q05 miss. We continue to believe that management is prudently taking a conservative approach to guidance given the inherently limited visibility of the book-and-ship business.
With the embedded business adding 3 more design wins - now at $7m / quarter and ramping, with only 13 of 51 design wins in production - and larger designs readying for 2006, we are increasingly confident in our estimates, rating, and target. We are only modestly adjusting our 2006 estimates bumping revenues down to reflect the lower guidance, but pushing EPS to $1.84 on improving margins sooner than we'd previously forecast. We also see revenue drivers emerging in the branch market, where the DSR series should drive improved attach rates, especially in DSView3 accounts, and in the serial market, where the CCM product should match up better versus sector leader Cyclades. Further, with the older versions of DSView heading toward end-of-life during 1H, we expect to see increasing penetration of DSView3 within current Avocent accounts, which is a classic customer lock-in strategy securing the installed base and likely driving sales of the DSR series. We believe there is potentially material upside to both revenue and margin estimates.
With the stock at $32.58, we find the case for AVCT compelling. Ex-cash of $6.95 / share, AVCT is priced at 15.1x our 2006 ex-cash EPS of $1.69. Given our long-term growth rate expectation of 13% - only in line with the market growth rate despite the deepest product portfolio tilted towards the fastest growth sectors - we find a PEG of 1.2 for a company of this quality astounding. We believe there is further upside to our projections, especially in embedded and KVM-over-IP digital products. We maintain our Buy rating and $39 12-month price target.
Public companies mentioned
None.
Company description
Avocent Corporation is the leading supplier of connectivity solutions for enterprise data centers, service providers and financial institutions worldwide. Branded products include switching, extension, intelligent platform management interface, remote access and video display solutions. Additional information is available at: www.avocent.com.
Analyst Certification
I, Anton Wahlman, hereby certify that the views expressed in this research report accurately reflect my personal views about the subject company (ies) and its (their) securities. I also certify that I have not been, am not, and will not be receiving direct or indirect compensation in exchange for expressing the specific recommendation(s) in this report.
I, Eric Kainer, hereby certify that the views expressed in this research report accurately reflect my personal views about the subject company (ies) and its (their) securities. I also certify that I have not been, am not, and will not be receiving direct or indirect compensation in exchange for expressing the specific recommendation(s) in this report.
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% for which investment banking services have been provided for in the past 12 months
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Hold 11
Under Perform 0
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Under Review 0
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