Investment Thesis
Performance Critical Telecom, “PCTEL” (PCTI) is a conservatively ran Midwest wireless antenna and testing solutions company. They manufacture physical antennas for wide universe of wireless devices and devices to test service for wireless networks. The company was a huge beneficiary of the 4G rollout and will also be a huge beneficiary of the 5G rollout. Management has conservatively cut guidance and set expectations accordingly for the next year as their wireless customers have reduced capital expenditures for 4G while they make plans for 5G. I expect the stock to more than double to $10 when the cycle picks up and we see the 5G explosion of IOT devices.
As I mentioned earlier, management is conservative. They are an old school operation in Illinois and the balance sheet is rock solid. They have over 40% of the market cap in cash, with no debt. This cash is not stranded; the company pays a 4.6% yield. The 4.6% yield is even better than it sounds. About 22 cents are paid as a return of capital, reducing your basis in the stock rather than being taxed as a dividend. Management has no plans of cutting the dividend, and has also implemented cost cutting measures to accommodate near term headwinds. The strong balance sheet greatly reduces downside risk for the stock and the dividend pays patient shareholders a healthy return while they Netflix & Chill for a year or 2.
“In our last earnings call, we mentioned revenue risk related to wireless operators reducing their spending on legacy systems in preparation for the capital expenditures required for 5G deployments. This reduction in capital expenditures impacted our Test and Measurement business in North America. As a result, RF solutions revenue was down 22% in the half. This reduction in capital expenditures, together with the uneven nature of the Connected Solutions segments project-driven demands create revenue and earnings challenges in the quarter.” – 2Q18 Earnings Call
Company Overview
PCTEL antennas are deployed in small cells, enterprise Wi-Fi access points, fleet management and transit systems, and in network equipment and devices for the Industrial Internet of Things “IOT”. PCTEL sells to a wide array of large networking OEM’s including Cisco (CSCO), Aruba and Huawei. They also sell to a wide array for smaller IOT players which will see massive unit growth with innovations in 5G, covering everything from fleet vehicles to smart grid, providing a crucial component for the third industrial revolution.
PCTEL Connected Solutions provides test tools that improve the performance of wireless networks globally. Mobile operators, neutral hosts, and equipment manufacturers rely on PCTEL to analyze, design, and optimize next generation wireless networks. In plain English, the Verizon’s (VZ) AT&T’s (T) and Sprint’s (S)/T-Mobile’s (TMUS) of the world need to have installers drive around with PCTEL scanners to make sure their customers have good service. They want to make pretty maps to show us their awesome coverage which justifies the cost of service, and conversely they want to minimize dead spots so we don’t flip out when we are streaming something and it stalls. PCTEL has strong market share of roughly 40%, comparable to their peer Rohde and Schwarz.
They have a strong market position in both segments, and also have strong track records with their installed base. Enterprise & industrial antennas while mission critical bear a relatively small cost as a percentage of their customer’s complete devices which insulates PCTEL from cheap generic competition. Similarly, network testing equipment is crucial to their customers while also a very small cost of the overall network rollout.
Valuation
Management has laid out 2022 targets of $12M-16M in EBITDA from $120-130 million in revenues, generating 10-12% EBITDA margins. This seems very reasonable. At the peak of 4G in fiscal 2014, PCTEL generated $107 million of revenues and earned 9.6% EBITDA margins. 5G technologies will be built on a large network of smaller cells rather than small network of larger cells, which means more testing from a more intense installation. 5G will also unlock new capabilities for the internet of things and will introduce more wireless technologies, which means more antennas will be needed.
The market will get really excited when the rollout gets real. This will probably happen in 2020, with 2019 being a slow year of limited pilot rollouts. At $15 million of EBITDA and a 10x multiple, the stock is worth $10.2. The stock was $7.6 earlier this year and trading at $10 in 2013 during the 4G peak, with 5G presenting a bigger market opportunity than 4G.
Financial Risk
PCTEL has already delivered their first 5G scanning receivers to 2 large customers and is well positioned for the upcoming 5G rollout. While they will most likely see huge order volumes from 5G, the timing of orders is heavily dependent on budgeting by their telecom customers.
With a slow ramp up of 5G orders and simultaneous pause in 4G orders, PCTEL profits have suffered and may continue suffering until the cycle gets more momentum. The company quickly swung from profitability to break even and is expected to lose money in the back half of 2018. In the first half of 2018, the company earned 2.1% adjusted EBITDA Margins, down from 7.5% in the first half of 2017. This translated to non-GAAP Loss Per Share of -$0.01 in the first half of 2018, down from non-GAAP earnings per share +$0.10 in the first half of 2017.
Management expects to see weakness in both segments for the remainder of 2018, and weakness in testing equipment until the first half of 2019. Full year 2018 revenue guidance is for revenues of $82-85 million, down from $91.4 million in 2017. Full year non-GAAP EPS guidance is for a loss of $0.04-0.07 per share. In conjunction with weak outlook, PCTEL is spending $700,000 to streamline expenses in the back half of 2018, which is expected to yield $1.8 million of annual cost savings in 2019 and get the company back to break even in this lull.
I believe that weakness in current fundamentals is fully reflected in the stock, which is now trading at 0.6x enterprise value to 2018 sales guidance ($50M / $82M), and 0.4x enterprise value to 2022 sales guidance ($50M / $125M) . PCTI was trading at over 1x EV/Sales at the end of 2017 ($93M / $91M). Over the past decade, PCTI has traded at a median of 0.8x enterprise value to sales, regularly trading over 1x at the peak of 4G (per Bloomberg). Airgain (AIRG), a wireless antenna company of similar size is trading at 1.7x 2018 enterprise value to sales (per Bloomberg).
Trump Risk
No different than Harley Davidson, Donald Trump has caused some ruckus for this Midwest operation. Management has not seen a material drop off in orders and has offset the tariffs with price increases, but there will be longer term risks of customers like Huawei sourcing locally.
“Approximately, 10% of our annual antenna revenue is impacted by the recent 301 tariffs on certain imports from China, which apply to our GPS and multi-band antennas and a limited number of related components. We instituted price increases to offset the impact of the tariffs. We don’t foresee trade issues related to our deliveries in China, but there is a longer-term risk to revenue if China-based customers decide to source more from non-US manufacturers… In the short term, we don’t have any serious concerns and I think we’ve talked about this in past calls. Longer term, if this does really start to retch it up, the Chinese government may suggest that the local manufacturers work with Chinese companies or non-US companies and in that case, it would affect PCTEL, but we don’t see it happening in the near term.” – 2Q18 Earnings Call
FCC Commentary Mitigates Risks
On September 28, 2018, FCC Chairman Ajit Pai stressed the importance of the US being first to market with 5G, “We need to seize the opportunities of 5G. Point two: Time is of the essence. We are not alone in our pursuit of 5G. The U.S. is in the lead, thanks to our private sector as well as the work of the FCC, this Administration, and Congress. But China, South Korea, and many other countries are eager to claim this mantle.”
With the White House and the FCC in their corner, wireless telecom capital expenditures will be made. By now, you probably heard of Verizon’s (VZ) initial implementation in Houston, Los Angeles, Sacramento and my current home city of Indianapolis. We should expect more announcements in the near future, which means we will see a lot of 5G investment. Per Ajit, “We’ll need an estimated 800,000 new cell sites by 2025. For perspective, we have barely a quarter of those today… An Accenture study pegs 5G’s potential at 3 million new jobs, $275 billion in private investment, and $500 billion in new economic growth.”
Ajit Pai also told us that the FCC is greasing the wheels with deregulation. Per Ajit, “The FCC is revising or repealing outdated rules to promote investment in the wired backbone of 5G networks. For instance, when I became Chairman, FCC regulations made it too hard for carriers to transition from the fading copper networks of the past to the fiber networks of tomorrow. So we’ve updated those rules to help companies focus on fiber deployment. We’re also making it cheaper and easier to string fiber lines on utility poles with one-touch make ready, which is critical for carrying 5G traffic to and from small cells.”
Conclusion
PCTEL is a company in great financial health sitting in a cyclical trough waiting for orders to pour in from a massive secular trend. The company has minimal earnings risk after the recent quarter and minimal capital risks. When the 5G cycle picks up, the stock should break double digits. Until then, you collect a 4.6% yield, favorably taxed as a non-dividend distribution.
“We believe the reduction in revenue and earnings are short-term issues and we remain fully committed to our long-term strategy to provide antennas, radios and test measurement systems that solve complex RF problems. In addition to investing in performance-critical solutions, we are improving our operations and focus to return PCTEL to our expected revenue and margin levels…“We plan to return to positive cash flow generation and it’s important to note that the Board is fully committed to maintaining the dividend.” – 2Q18 Earnings Call
Disclosure: I am/we are long PCTI.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
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