Should you buy the dip on Audinate?

On Tuesday, Audinate Group (ASX: AD8) released its FY24 Preliminary Unaudited Results & FY25 Outlook. While the result for FY24 in itself was good, it was the company's outlook statement that left a sour taste in investors' mouths. 

As the company explained in the update, revenues for FY25 face a combination of headwinds, including: 

• The preference for software-based Dante implementations is expected to increase during FY25, driving the business's overall margin towards 80%. Software Dante implementations drive adoption via hardware cost savings for equipment manufacturers, however, per-unit revenue is lower.
• Shortening order lead times, re-balancing of inventory holdings across the industry and the rate at which our manufacturing customers clear raw material inventory will influence our FY25 result.
• Expected end-of-life of Viper and MY16 products. 

With these headwinds in mind, Audinate expects its gross profits will be marginally lower in FY25, and revenues will likely decline too. However, the company expects it will return to growth and predictable order patterns in FY26. 

It seemed investors weren't willing to wait that long - with the stock selling off 50% on Tuesday after the announcement. Since then, Audinate's share price has rebounded around 31% - but it's still now trading at levels not seen for at least a year. 

So, is it time to be loading up on Audinate? Or should you sell your holdings while you can? 

To find out, Livewire spoke with Elston Asset Management's Justin Woerner. 

Is the sell-off a buying opportunity? 

Justin Woerner: We still view AD8 as a company that ticks many of our quality requirements. We don’t see the latest update impacting our longer-term thesis for the business.

We believe the underlying thematics discussed in the update have been flagged by management for some time. We were surprised by the timing of the update, and to some degree the magnitude. However, we have been expecting the underlying impact of the product mix shift and COVID-19 unwind to start flowing through the financials.

In hindsight, management may have done a better job of taking the market on the journey with them.

Let's go back to basics, why do you like the company? 

We are long-term investors, so we look for a lot of long-term quality attributes. Audinate ticks a lot of those boxes. For example, it's founder-led and it's operating in a very large under-penetrated global TAM. There are structural tailwinds as Audinate's digital technology disrupts analog and there are high barriers to entry, given the level of IP and OEM (original equipment manufacturers) relationships. That technology has strong network effects as well. 

The more OEMs you get, the stronger your network effect becomes. They're the clear market leader, with 12 times the penetration of the number two player, and they've got a very strong value proposition. 

They are committed to investing in product development. So, we see a future runway across their ability to extend their product offering and their value proposition. Lastly, they sit in a net cash position. So, there are no real concerns about the balance sheet.

What are the red flags that bears usually call upon when they trash the business? How would you rebut these? 

For me, investors need to figure out whether they are dealing with an issue around the company fundamentals, or whether you are just dealing with an issue around market expectations. 

The first half result was quite strong, but there were probably a lot of cyclical drivers in that.  Management was aware of that and perhaps, the market just extrapolated some of that growth. The share price went on a bit of a tear post the first-half result - it was getting up around $24. For us, as long-term holders of the stock, we were trimming our position when it was going past $20. 

Now, a lot of that heat has come off and expectations have come back too. We believe the pendulum has now swung too far the other way, so we're adding to our position. 

We think there's a lot of growth in this company. If you look at market penetration, it's anywhere between 10-15% - depending on how you measure it, but either way, it's pretty low. In the long term, we think the disruption of analogue will continue and Audinate can be multiples of what it is at the moment in five years. So over the longer term, it's very well positioned.

We think video is where Audinate's audio business was 15 years ago - it's still early days, but we think Audinate is in a pretty good position. 

Is there anything investors should be aware of ahead of Audinate's actual report in August?

Yes, I think there are probably a couple of things investors should keep an eye on. For the audio business, it's better understanding the transition coming out of COVID-19 - so I want to see additional information on how they are going with their hardware unit sales and how they are going with software sales. 

I also want to see commentary around video - are they adding OEMs, which OEMs are they adding, and the number of products that they've enabled in the market? We want to see some continued growth, given they had pretty strong growth in the first half coming off a low base.

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