NetComm: strengthening the balance sheet

We maintain a buy and are comfortable with the long term goals and projects NTC is chasing.

NetComm Wireless (NTC) this morning announced a fully underwritten $50 million placement of ordinary shares to sophisticated and institutional investors, with a minimum price of $2.93 (9.9 per cent discount to last closing price of $3.25). This means a maximum of 17,064,846 ordinary NTC shares will be issued dependent on the final placement price.

Additionally, there will also be a Share Purchase Plan (SPP) to raise up to another $10 million. The SPP provides the opportunity for shareholders on the register on April 19 to subscribe for another 15,000 NTC shares at the same price at the final placement price (minimum $2.93). Given approximately 80 per cent of the register is retail, this SPP is likely to be heavily scaled back.

We view the capital raising as a positive development, in introducing new institutional investors to the largely retail focused register, and further providing the capital for NTC to safely progress with multiple local and overseas growth opportunities.

As previously discussed, NTC has gained a first mover advantage in the global roll-out of high speed fixed wireless broadband to regional markets. With the Ericsson/NBN project being the only demonstrable in-field solution globally, NTC was successful last year in signing a fixed wireless Master Purchase Agreement with a large US based telco operator. The company is likely to win further contracts, given they are involved in the first two large scale fixed wireless projects globally.

As part of the capital raising announced today, the company stated that the placement proceeds will fund:

– Additional investment in engineering (R&D) resources, with an increase in engineers from 80 to over 122, to further develop software and new product solutions for existing and potential customers,

– Additional investment in sales and marketing with a planned increase in staff from 60 to 74,

– Additional infrastructure to ramp up delivery of existing contracts given the rapid rollout profiles of both the Ericsson/NBN project and the US fixed wireless project,

– Enhanced capabilities to progress new global fixed wireless opportunities already in the pipeline,

– Development and acceleration of a number of major projects that will position NTC at the forefront of fixed wireless and M2M globally,

– Repayment of existing debt facility, and ensure can meet the general working capital needs of the business.

Trading update (announced April 15)

Last week, the company announced a full year FY16 trading update with key details below:-

– Revenue of approximately $85m ( 14.4 per cent on FY15).

– With fixed Broadband or “Base” business revenue of $28m compared to FY15 of $40.5m, with $30m believed to be a long term sustainable level. FY15 “base” revenue included the one-off gain from sales to a key customer, following a major marketing initiative by that company.

– The Fixed Wireless and M2M revenue is expected to be up 68.6 per cent, to $57m due to continued growth in the Ericsson/NBN Fixed Wireless project and several new M2M projects.

EBITDA of approximately $6.4m, down slightly on FY15’s result, reflecting:

– $4.3m investment in staff, skills and infrastructure to deliver on the substantial growth opportunities available, and

–  $0.7m non-cash accounting expense associated with Share Appreciation Rights approved at the Company’s November 2015 AGM.

Underlying EBITDA – before investment in staff, skills and infrastructure – is expected to be $11.4m, which is a 25.3 per cent increase on FY15 underlying EBITDA of $9.1m.

The main reason for the lower guidance is that NTC NBN fixed wireless sales are expected to be 80k, rather than the 85k previously forecast. This is still extremely high growth vs. the 33k in FY15. We are not concerned by the slightly lower forecast, as it just slips into FY17 and we are confident the fixed wireless rollout rate will continue to increase in momentum – with FY18 forecasts approximately double that of FY16.

The base business forecast revenue of $28m is slightly lower than expected, but this division will become less relevant in future years as the company increasingly shifts its attention to M2M and fixed wireless opportunities.

The company also provided general guidance for strong growth in FY17 - driven by an increased pace of rollout for the Ericsson/NBN Fixed Wireless project, and commencement of orders from the fixed wireless Master Purchase Agreement in the US. Further, new fixed wireless and M2M projects in Australia and overseas are currently in the development pipeline.

Valuation

The high FY15/FY16 PE is completely irrelevant to the valuation or recommendation of NTC. The reason for this is that US rural broadband hasn’t started contributing to earnings, and the Australian rural NBN rollout rate is expected to double by FY18. Also expansion costs are included in the reported numbers that won’t benefit revenues until future years.

If not convinced how irrelevant this year’s PE ratio is, it is worth considering that the US contract doesn’t start contributing to earnings until FY17, and with base level assumptions will produce $150m revenue in FY18 – ie. over double group revenue for FY15, and roughly 80 per cent higher than the FY16 group revenue forecast. This US rollout will continue for at least six years. Similarly, Australian NBN revenues are expected to approximately double by FY18.

NTC’s work involves many politically sensitive projects, and as such not all details can be announced. For example, with the US rural broadband contract it has just been announced that it is with “one of the two largest US based telecommunications carriers”.

As a further example of politically sensitive work, NTC is currently bidding for the NBN FTTdp work. This has the potential to be very material, with an announcement date expected in July.

Prior to this capital raising our valuation of $3.60 only included conservative assumptions for the US fixed wireless contract and Australian NBN, the base business remaining at $30m revenues, and other M2M less than $30m.

Rather than retaining the very strong increase in cash-flow forecast over the next few years, clearly the company’s strategy is to invest for further growth. This makes the valuation process difficult as it is hard to forecast what rate of success the company will have with this re-investment.

Our valuation is currently under review, but we are confident over the longer term the stock will be well north of $3. We are maintaining our BUY recommendation, and will update our $3.60 valuation in coming weeks after the capital raising price is confirmed.