Equity research: Symmetricom, Inc. (Part 7 of 7)
Risks and mitigants
Risk #1: Given the end-markets and instruments-heavy (non-contracted) government business, SYMM has limited visibility into its future book (six-month backlog is roughly a third of future revenue) and a lot of government business is on the sequester chopping block.
- Mitigant: SYMM PackeTime systems was already integrated into >150 networks worldwide as of June 2012. It would likely be disruptive and cost-inefficient to switch synchronization options among existing backhaul customers.
- Mitigant: A (17%) annual decline in Old SYMM government business is expected to be offset by a CSAC book, which while lumpy, is well-positioned to grow in the E&P channel. Other possible growth channel anticipated in packet-based sync solutions for power/utilities sector.
- Mitigant: SYMM has an extensive partnership network through its Syncworld Ecosystem Program that extends globally across all aspects of packet-based infrastructure and is well-positioned to take advantage of the migration to packet-based networks.
Risk #2: Management: The Company is undergoing a leadership transition in the midst of a major operational restructuring. The new CEO has never been a SYMM manager.
- Mitigant: Substantial amount of compensation tied to performance-based hurdles (categories/levels TBD) and options struck +13% above the current level.
- Mitigant: New CEO knows the company, having held a board seat at SYMM for more than ten years.
- Risk #3: Operators forgo PTP in favor of another synchronization standard in the process of migrating their backhaul.
- Mitigant: PTP is viewed as the superior packet-based standard. European operators are ahead of the curve on PTP implementation and have already implemented successful frequency/time/phase sync implementations in the new standard.
- Mitigant: There is no “one size fits all” for network sync in a packet-based world. Network operators have shown some interest in an “any two will do” approach whereby one standard satisfies one sync imperative (e.g. frequency sync), while another standard meets an alternative need (e.g. time sync). PTP is well suited to be deployed with other standards where desired (while remaining superior) because of its flexibility in sync imperatives.
Risk #4: Highly competitive marketplace across both channels of “New SYMM” growth. SYMM is squaring up against some large names in Microsemi/Juniper in packet sync/solutions and Dover/Swatch in oscillators (CSAC-type)
- Mitigant: SYMM was among first to market with PTP sync and has patents on CSAC. The company, while small, is a globally recognized brand name in the timekeeping space.
- Mitigant: Most of the large competitors have only small (some non-core) segments that are competing with SYMM. An extensive partnership network with large players like Alcatel-Lucent, Broadcom, Cavium, and Qualcomm affords good visibility for the smaller SYMM.
Risk #5: SYMM effectively relies on a sole source, Kyocera, to manufacture its CSAC product.
- Mitigant: CSAC production facility is located in San Diego, near to SYMM HQ, improving supply logistics. The facility was recently expanded to address SYMM production needs.
- Mitigant: SYMM holds about five months’ worth of total inventory (1.5 of finished goods) at any given time. It could presumably deplete while it finds a replacement supplier or during a disruption
Valuation and returns
I value SYMM’s base case on both a DCF and multiples basis with the following assumptions:
- DCF: 7% WACC (beta is only 0.9 as business is unlevered), 2% decline in perpetuity equivalent to a 7.6x terminal EBITDA (earnings before interst, tax, depreciation, and amortization) multiple
- EBITDA multiples of 8x to 9x at the average of the forward comps range and FCF multiples at 13x, a discount to the current LTM median of 17x
- Synchronization communication comps: CRNT, FEIM, Huawei, Swatch (via Oscilloquartz), JNPR (via acquisition of Brilliant Telecom) and CRNT
- Embedded solutions communication comps: FEIM, TRMB, MSCC and SMTC
- Government and enterprise comps: FEIM, Orolia, DOV (via Vectron) and Rakon
- A few words on FEIM: Business has almost 100% backlog coverage by virtue of a 75% book providing timekeeping solutions (clocks, frequency sources/synthesizers and receivers) to the satellites end-market including major construction projects for Boeing and Iridium’s NEXT constellation. The business model is pretty leverageable and each satellite booked currently adds about $5 to $10 million of revenue, with that number expected to grow as more components are introduced per satellite. The business currently does just under 40% gross margins, but is making use of operating leverage to expand profitability. It is a name I am considering diving into in the future with stock trading just ahead of tangible book.
I average out the valuations (see table above) to get to roughly a +35% base case. In terms of a downside, I anticipate that, at worst, the business trades to net-net levels (including NOLs/tax credits) at a (13%) discount to the current price.
The Market Realist Take
In its September 10K filing, Symmetricom said that during fiscal 2013, it remained focused on driving new opportunities for growth in key areas such as PackeTime, the Quantum Chip Scale Atomic Clock (or CSAC), and government programs. It enhanced its solution portfolio for service providers transitioning to packet-based networks or LTE and LTE-Advanced wireless technologies with the launch of its PackeTime Edgemaster product. Its Quantum CSAC revenue increased in fiscal 2013 on higher order volumes and production levels. CSAC’s significant size, weight, and power advantages over existing technologies continue to drive demand. With a strong backlog in place at the end of the fiscal year and increasing production volumes, the company said it is well positioned for CSAC revenue growth in fiscal 2014. Plus, its Government Programs portfolio performed well despite the challenging government spending environment. Symmetricom believes its technology and expertise are well aligned with the new defense priorities, and it plans continued investment in this area as it pursues long-term growth.
However, revenue in other, more mature product areas was adversely impacted by the government spending weakness and broad-based economic weakness, leading to a decline in total company revenue from fiscal 2012. Despite the challenging year, Symmetricom continued to generate cash, with over $19 million in cash flow from operations and added nearly $9 million to its cash and short-term investment balances.
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