Thursday, March 28th, 2019
Audinate (AD8) is an emerging technology leader at a positive inflexion in its trajectory, one we see as a candidate for inclusion in the ASX Model Portfolio.
AD8 develops and markets digital audio networking technology. Its flagship product set, Dante, comprises hardware (chips, modules, and software) and software that is embedded within audio products of its Original Equipment Manufacturer (OEM) customers.
Dante enables distribution of audio signals over computer networks – “audio over IP” – which yields significant advantages over analogue “point-to-point” technologies. Professional AV system operators use Dante in commercial installations, broadcasting, transport, stadiums, and live sound systems.
Although AD8 appears expensive trading at over 10 times FY19 sales and close to 100 times earnings, in our view such metrics aren’t yet appropriate measures of value.
AD8’s significant underlying market power belies its small-cap status. The addressable market for the Dante Audio and AV (audio and Video) product suites is estimated at over $1bn against AD8’s forward revenue of approximately $30m, reflecting only 3% capture.
Interestingly, due to the complex nature of audio networking and the requirement for interoperability, end markets favour a single technology provider. Dante is set to become the “de-facto standard” for audio networking having established a dominant share of OEM adoption.
This dynamic is evident in accelerating OEM adoption of Dante over competing technologies, with the number of products incorporating Dante at over 1,800, about 5 times the nearest competitor.
Based on our discussions with AV professionals – the end users of Dante-enabled equipment and associated software – Dante is highly effective, and there is no going back to analogue audio distribution after making the switch to digital. Over time it is likely that AD8 will capture a material share of the addressable market.
AD8’s dominance in terms of OEM adoption is also reflected in very high gross margins (on chips, modules, and software) at 75%.
Given much of product development is now complete with the launch of the Dante AV (enabling video distribution along with audio) in February 2019, and marketing costs will likely plateau due to a network effect reinforcing adoption by OEMs and end-users, we expect only incremental increases to operating expenses.
This means incremental revenues should fall very potently to the bottom line. With 1H19 sales growth tracking at 50%, we see strong earnings growth over the near to medium term.
All well and good, one might argue, but isn’t this in the price?
Assuming gross margins remain at 75% and operating expenses grow at say 10%, AD8 will need $70m of revenue to deliver earnings of $20m. The current market capitalisation of $320m represents a multiple of 16 times (a market multiple) on this level of earnings. However, $70m of sales is still only 7% of the addressable opportunity – in a winner-take-all industry.
So, although AD8 needs to grow to justify its market valuation, the opportunity is certainly not “in the price”. On our numbers, AD8’s FY19 valuation is $8.13, and we will update on further evidence of strong execution.
Clime Group owns shares in AD8.