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#2 $AD8 - Ignoring the recent drawdown in share price, what needs to happen for this share price to make sense
Overview
In the financial press, the main headlines on $AD8 have focused on a) the sharp fall in the $AD8 share price given their weak guidance for H2'24 b) the poor optics around insider sales before a share issuance and c) how the business will be a multiple of the size if it can penetrate the video market
For this article, I think item (c) is the only thing that matters in the long term and the valuation prospects.
Why you should even consider this business
Safe to assume a 5-6% CAGR for this sector ($325bn to $433bn between 2024-29)
Market share is c.9% as at 2024
By a reminder:
Dante sells in two functions either via
$AD8 Chips to accompany OEM-made chips with product development software as well as either (a) free application Dante Controller & (b) paid for Dante Domain manager
Standalone $AD8 chips where they do not need to include OEM chips. They break it down as follows:
Higher-priced is suitable for higher channel counts - Brooklyn
Medium channel-count - Broadway
Low-priced & low channel count - Ultimo (typically for speakers and microphones).
This is set out below
Drivers for this Business
$AD8 is not the most complicated business, but there are a lot of datapoints you can observe which are a waste of time.The way I look at it is:
What is $AD8's penetration in the market (instead of focusing on overall TAM growth)
How many units have been shipped (noting inventory levels change)
Revenue per unit
Any other opex/balance sheet factors impacting the valuation of the business.
Here is an excerpt of the financials to date (I have run my own forecasts below)
As you can see there are some apparent trends in future growth
Revenue per unit for video is way larger than Audio
Number of shipping OEMs is way smaller (and so is the addressable market)
Growth rates for Audio/Software have stabilised so that should not be the focus of the valuation
How to value $AD8
Unimportant items
Restocking/destocking in OEMs - Whilst obviously a P&L driver is one-off so I wouldn't put much value here nor would I ascribe much value to discontinuation of software (e.g. Viper) is unimportant in my mind
Multiple expansion potentional - Whether the Video business will command a higher video multiple; this would be "nice to have" but video is very nascent
Level of R&D capex - this will run at about 20% in the long run so a drop/lift in a period is not something I focus on
Cash balance - yes they have a good cash runway (over $100m) but this is not the main valuation driver; you're still valuing $650m of asset after net cash balance
Items to observe
LTIP- Challenges in meeting long-term incentive targets, requiring around 50% growth by FY26 to achieve the minimum hurdle. My concern is whether this is their LTIP is out of the money leads to staff attrition
M&A They have walked away from 2x deals in 2024 (not necessarily a bad thing). However, there will be pressure on the newly hired Chief Strategy Officer to get runs on the board. My fear is they burn their $100m cash kitty on video tech deals to get their LTIP
Costs Management: Management noted that opex will grow by 7-9%, an improvement from the >28% p.a. over the past three years. If they can genuinely extract higher operational leverage, today's share price could be more reasonable
Key valuation assumptions
Growing penetration: There are some easy assumptions to make:
Audio penetration will increase from 55% to >65%
Software sales, after adjusting for Viper will grow at a slowish rate
The tough assumption is around video penetration growing from 21% to 48% or from 30k units to >85k units and here is where the whole thesis falls down - to achieve a c.$10.5-$11.5/share price that you would hope for, you need to assume a doubling of video units & I simply do not know the competitive landscape for the video product and this seems like a stretch
Expense management: Offsetting this, I do see a scenario where Employee expenses are lower (c.40% of revenue), Admin Expenses come down and EBITDA margin grows to say mid-20%; which is a key focus of management - as seen in the management pack below:
Conclusion: Whilst I genuinely think this is an appealing business (founder led, leader in fragmented space). My largest issue is:
I think it is bullish to assume their Video Revenue reaches $15m by 2028 which is still only 10% of revenue
Running reasonable growth to 2028, I can imagine revenue reaches $140m and EBITDA of $35m
Given today's EV is c.$660m - you essentially have to wait 4yrs to get a <18x EBITDA
Despite all the favourable press about the fall in the share price, I think this company is worth an EV of c.$500m (unless there are huge operational efficiencies obtained to assume a higher EBITDA margin going forward)
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