The first half of 2020 had already got off to a slow start for Audinate, with revenue growth (in USD) up 7.9%, well below the growth rates of recent years. The company put this down to tariffs imposed by the US on Chinese-produced goods (where AD8’s products are made). Then in the second half revenue went backwards due to COVID-19 disruptions, making the full year effectively flat in US dollar terms.

In the second half, the company moved to contain its cost base. Headcount was reduced, pay and bonus freezes were implemented and discretionary expenditure was cut.

In their reporting currency of AUD, revenue grew 7% to $30.3 million and EBITDA fell 27% to $2 million. The company went from generating a small profit before tax in 2019 to a loss of $1.5 million in 2020. Cash flow improved on the previous year due to better working capital management.

The company finished 2020 with a cash balance of $29 million. This was subsequently bolstered to $69 million in July 2020 following a capital raising designed to strengthen the balance sheet and accelerate product development and potential M&A.

The current weakness in sales does not appear to be due to competitive pressure. Over the last five years AD8 has grown to be far and away the market leader, as shown in the chart below.

Dante is well on the way to becoming the accepted industry standard. It should be noted though that whilst AD8 is the clear leader among the independent providers, equipment manufacturers do have the option of developing their own proprietary solutions, and this could represent a risk in the future.

A number of other software and technology companies managed to grow strongly through the disruptions caused by COVID-19. With the strong industry tailwinds for Dante, why couldn’t AD8 do likewise in 2020?

The core of the problem seems to be that although trends are favourable for Dante, AD8 is still hostage to what is going on with their customers, and this is subject to macroeconomic events.

In the first half, manufacturing impacts caused by tariff changes could genuinely be considered a one-off shock. AD8 was able to mitigate the damage by shifting some production to Malaysia, and their customers were looking at similar strategies.

The impacts of COVID-19, on the face of it, look like they should also snap back once economies return to normal. But AD8’s product range skews towards events where there are large public gatherings such as concerts and sporting events. Even when such public events resume, venue owners and operators could be facing a prolonged period of weaker than usual demand and financial pressures constraining capital budgets.

Audinate pointed to some positive leading indicators. The number of Dante-enabled products finished the year 31% higher. The company conducted extensive product training and seminars, and new products are due for release during the year. But at this stage, performance is “currently below the level required to generate revenue growth in 2021”, so things are still going backwards.

Audinate is currently loss making. Valuing it on a similar basis to other high-growth software companies, AD8 is currently trading on a 2022 EV/Revenue multiple of 12.4, which is high versus peers.

Alternatively, using a simple EPS discount model with consensus forecasts for the next three years to profitability, and assuming a discount rate of 7.5% and a terminal growth rate of 4.5%, AD8 would need to grow earnings by about 25% p.a. over the following 7 years to justify the current share price of $5.40.

Audinate is still well positioned to take advantage of the transition to digital audio networking and has ample cash to see it through a downturn in 2021. But the muted short term outlook combined with high multiples and implied growth rates makes the valuation look challenging at this time. 

At $5.40 the share price is currently below the important trend defining red line which does NOT support a positive conclusion.

Audinate has huge potential however neither the trend nor the valuation support a positive conclusion at this point in time.

Disclosure: The author does NOT hold shares in AD8.

Neither The Super Investor nor the author has received [or will receive] any benefit whatsoever from any party at all for the publication of this article.

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