Equity research: Symmetricom, Inc. (Part 4 of 7)
Symmetricom, Inc. (SYMM) and chip-scale atomic oscillators (CSACs)
When a ship wants to assess a deepwater zone for E&P (exploration and production) drilling, it usually tosses a net of regularly spaced sensors overboard over an area of the ocean floor. It then blasts radio wave signals from all sides onto the net area, striking the ocean floor. Some waves bounce back directly, while others penetrate the ocean floor and strike rock, oil, or natural gas before being reflected back to the floor and hitting the sensors. Based on the time it takes to be reflected, engineers can determine with high probability whether there is oil or gas in that zone. This technology is termed “reflective seismology” and requires high precision and durability given the cold temperatures and high water pressure.
Since debuting commercially via SYMM for $1,500 a pop, the CSAC device has shown tremendous traction among E&P players when they have sought to deploy deepwater exploration capex. Douglas-Westwood forecasts $223 billion of deepwater exploration capex over the 2013–2017 period, double the amount spent in the preceding five-year period. The “Golden Triangle” of deep water will dominate expenditure over the next five years with activity in the Gulf of Mexico, West Africa, and Brazil. My research suggests that though drilling is volatile, the current WTI/NYMEX spot and future strips support economical deepwater drilling. Moreover, offshore drillers initially showed some trepidation in the prior drill cycle after what happened to BP and during the Shale Revolution of recent years. To sustain energy efficiency and extend sensor life, CSACs are clearly differentiated above incumbent undersea frequency technologies like the TCXOs, though I should note that SYMM is a seller of both solutions.
The other end-market driver of CSAC demand is in contracted business out of the defense industry. This device was after all the brain-child of DARPA (the Defense Advanced Research Projects Agency) before going commercial through SYMM. Heretofore, most CSAC demand has been in the E&P space, but there are clear uses and interest for CSAC in defense situations where GPS is unavailable or suboptimal, such as with IED jammers and UAVs. I am not sure if any CSACs make up the current fleet of drones that have been in the news, but my expectation is that any CSAC government business should be viewed mainly as upside to the thesis in lieu of ongoing defense uncertainty.
In sum, I forecast +20% CSAC end-market growth based primarily on strong deepwater drilling prospects.
In the context of other government business, the sequestration has clearly impacted SYMM, amid forecasts for future budgetary tightening. CSAC orders have been lumpy and limited, so the differential impact of reduced government spending has been seen in (8%) and (16%) y/y declines during FQ2 and FQ3, respectively. Based on management’s consolidated revenue guidance, FQ4 government/enterprise revenue is expected to be down (23%) year-over-year if we assume the same current mix between the two segments.
In the context of contracted government business, management generally refers to the C4ISTR portion of the defense budget as the relevant guide to such end-market demand. Frost & Sullivan anticipate the C4ISTR will decline from $76 billion in 2012 to $45 billion in 2017, a (10%) CAGR (compound annual growth rate). I have assumed a 15%-to-20% annual decline for the “Old SYMM” government business, because in truth, a good chunk of that sits outside hard contract and is likely more at risk. That said, SYMM remains a clear market leader in frequency reference and instruments given its overwhelming contribution to UTC timekeeping.
Financial wrap-up and restructuring
As detailed in the thesis section, I arrive at a +3% base case revenue growth beginning in FQ4’14 based on +3% in communications blended across PackeTime and Traditional Sync, and +1.5% across CSAC, potential new power/utility and old government books.
In addition, I flow through $6.3 million of cash restructuring costs as part of last week’s headcount reduction announcement. The spend goes through the end of the calendar year before the savings begin to materialize in enhanced gross margins and roughly $5 mullion of fixed overhead/salaried labor eliminations. I assume SG&A (selling, general, and administrative expenses) grow at +2% thereafter with inflation.
I also assume elevated R&D (research and development) spending persists at 16% to 17% of sales through the end of FY’15, after which a new product roadmap should hopefully be fleshed out to coincide with “New SYMM” maturation. Thereafter, I run R&D at 13% of sales.
Working capital remains at roughly one-third of sales and capex is maintained at $5 million per annum.
The Market Realist Take
Network service providers are driven by increased bandwidth demand from end users and a need for reduced operating expenses to evolve their infrastructure toward packet-based technologies. In fiscal 2013, Symmetricom continued to participate in the deployment and modernization of various synchronization networks around the world. Its products also enabled operators of multiple cable television systems to enhance the performance of their broadband offering.
It continued to build a strong portfolio of precise timing and frequency solutions to address all layers of existing circuit-switched networks and the growing synchronization requirements of next-generation packet networks. The addition of a broader range of embedded solutions enables network equipment manufacturers and silicon solution developers to provide robust synchronization solutions as part of their own offerings.
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