Audinate: It's not cheap, and it's not growing

There's a lot for investors to get excited about when it comes to Audinate (ASX:AD8), the leading provider of professional digital audio networking technologies globally. Unfortunately, this year's share price performance is not one of them. The stock, which is one of the most tipped small-caps in Livewire's annual reader survey, is down 36% year to date, making it the second-worst performer on the list. I spoke with three investors following the release of AD8's results to get a sense on the issues facing the stock and to hear their views on the current outlook.

Each of the portfolio managers I spoke with name Audinate as a market leader with a great product and plenty of headroom to grow its customer base. Audinate's lead product is called Dante, and it is estimated to have eight times the market penetration of the nearest competitor product. Management reckons Dante currently has about 7% penetration of the billion-dollar total addressable market. So, the long-term runway looks pretty good.

The main issue that continued to surface in my discussions is the current growth rate (or lack thereof) and the valuation. The stock is valued at around $380 million and posted a net loss of $4.8 million for FY20. Year-on-year revenues were effectively flat at ~US$20 million, and management suggests revenues are unlikely to grow in the current financial year.

Josh Clark, Portfolio Manager at QVG Capital, has followed the stock since IPO but has never owned it.

"There's a very long tailwind, but it's going to take them years to grow into the valuation," Clark says, having spoken with many industry professionals about the company.

He's rock-solid in his belief Audinate holds the dominant position in their market. But he flags its lack of earnings as a concern.

"They are the dominant player in audio, so you would have liked to think they're able to make more money," Clark says.

Crippled by COVID

COVID19 has crippled Audinate's client base. The firm provides audio hardware to end users like stadiums, conference centres and transport hubs. With mass gatherings on hold indefinitely, there is little demand for venues to spend big on significant upgrades to their audio infrastructure.

Claude Walker, from the investment website A Rich Life, has owned the stock since 2018. He has reduced his holding more recently and opted out of the latest capital raising.

"The key point is the massive impact COVID has had on demand for networked audio with the company presenting research suggesting there was a 37% decline in demand for 2020. This is reflected in a reduction in revenue half on half," he says

Walker says his current portfolio weight of 0.25% is "symbolic" and Audinate is one of the smallest positions in his portfolio as he awaits clarity on the current pandemic.

"If demand does not rebound in 2021, then revenue could drop further," he warns

"It's not super cheap, and it's not growing."

Positive action

Jonathan Wilson, co-portfolio manager of the Clime Small Companies Fund, agrees the current environment is challenging for the stock but lauds the positive actions of Audinate's management. In the absence of new sales, the company has been proactively engaging with AV professionals to entrench its products further ahead of a return to normal operating conditions.

"They're kicking goals in developing the brand with AV professionals. They've used this time to increase education and continue to extend their lead over the competition," Wilson says.

He notes the company is flush with cash following a recent capital raising and suggests M&A opportunities could be on the cards. This presents a bit of a dilemma given the company has traditionally focused on organic growth, but he is willing to back management's judgement here.

The stock currently sits outside of the top five holdings in Clime's small-cap portfolio, and Wilson says it is a case of balancing near term uncertainty with the bigger picture.

"We haven't changed our position, and the portfolio weight reflects our view on the long-term opportunity," Wilson says.

Ben Clark from TMS Capital is more upbeat, nominating the stock as a small-cap pick in a recent episode of Buy Hold Sell. Clark is looking through the stalled revenue numbers and is focusing on new products that management is developing.

"They raised about $30 million recently, and what they're going to be using those funds for is R&D to develop new products that are going to benefit the COVID environment. So, that's helping their customers deal with employees working remotely, customers buying remotely and online learning."

In the current environment, investors are backing those companies that can offer near term certainty. The lack of a clear growth catalyst and the high valuation looks to be weighing heavily on the minds of investors.