Audinate owns technology that enables audio signals to be transmitted over standard ethernet cables – the same type of fiber optic cable you might use to connect your internet router to a computer or smart TV. I first recommended Audinate Corporation (ASX: AD8) in January 2018 when I worked for Motley Fool Hidden Gems, and it has been regularly covered by these pixels, so I imagine most readers are familiar with the business.
Originally, ethernet wasn’t designed with audio in mind. As Sound On Sound noted, “the original Ethernet protocol… was fundamentally unsuited to the job of transporting high-performance audio.” Audinate’s proprietary Dante technology provides the most popular solution to this problem.
Slide 14 from the recent AGM Presentation highlights how its advantage over the competition has only increased in the years since I first started following the stock.
Today, Dante is more or less essential for interoperability between original equipment manufacturer (OEM) brands like Yamaha and Bosche.
This also means it is becoming increasingly important for AV professionals to have trained on Dante. I expect as more professionals take that leap, Dante’s lead will only grow stronger. Arguably, though, the market has recognised and priced in Audinate’s leadership in audio networking.
The next frontier for Audinate is now video networking and it boasted that there were 84 Dante video products launched by customers at the end of FY24, up from 48 products at FY23. On the AGM conference call, the Audinate CEO Aidan Williams said, “This is a strong indicator that we’re laying the foundation for accelerating broader adoption over the medium term.” He further added that, “having lived through the hard yards of actually getting Dante audio started, I feel that Dante video is going something like 2 to 3x faster than the audio adoption side of it was.”
Obviously, the suggestion here is that Audinate could replicate something somewhat resembling its audio success in video networking, despite the fact that “On the video side of things, it is fragmented. It’s quite fragmented by technologies.” Realistically, the degree to which Audinate succeeds in video will be very meaningful for the success of the investment thesis.
Audinate’s Disappointing Guidance
A couple of weeks prior to releasing FY 2024 results, Audinate warned the market that it expected “generate US$ gross profit marginally lower than FY24, and there will likely be a decline in revenue in FY25, before a return to anticipated growth and more predictable order patterns in FY26.”
Then, at the time of its Annual General Meeting earlier this month, it announced that it had achieved just US$7.2m in gross profit for the September quarter. Furthermore, it said it expected “a Q2 gross profit run rate in line with Q1 FY25,” and “Management will update the market on performance and outlook after completion of trading in Q2 FY25, anticipating a moderately stronger second half.”
If we assume that means something like US$14.4 million in the first half, and US$15.6 million in the second half, that would leave us with US$30 million for the full year. As you can see in the chart below, that takes Audinate’s US Dollar gross profit back to below FY 2023 levels, a whopping drop of 32%.
The main culprit causing the lower gross profit is OEM customers reducing their own stock of Audinate products.
The Audinate CEO said on the conference call that, “We will work our way through the inventory in our customers, sitting in our customers. That will happen at some point.” The presentation prologue clarified that, “As of right now we are expecting this to only take a year, but obviously, that’s a projection that could change in the future.”
When its customers finally work they way through their backlog, gross profit should return to growth.
However, in the meantime, there is pain ahead. Audinate is on track for a whopping loss in FY 2025, given that costs are expected to grow in the range of 7% – 9%. Analysts downgraded their estimates for FY 2025 after the AGM announcement and are now expecting an EBIT loss of around $16m to $17m. Similarly, the share price declined from above $10 to below its last closing price of $9.06.
Sentiment around the stock is much more negative, and the cyclical non-recurring nature of the business is now front of mind. Temporarily, it will stop looking like a growth stock.
Since Audinate has $117m in cash & term deposits, I’m pretty sure it will easily make it through this downturn, and once it does, I expect sentiment to turn more positive. The quiet truth that Audinate has pricing power, plenty of room to grow, and a huge global market to address has reduced to a whisper. For now.
Audinate has a good track record of growing revenue, simply by supplying more products to more customers, as you can see below in the image from its recent AGM presentation.
In FY 2024, Audinate made a profit of $10.4 million, putting the business on around 75x earnings based on its current market capitalisation of $755 million. However, Audinate will make a steep loss in FY 2025, so it is probably easier to think about valuation using gross profit.
For Audinate, gross profit is a little bit like revenue for a software company.
Using my estimate of ~US$30m in gross profit, we get a bit over $45m AUD at current exchange rates. Now, Audinate has a lot of excess cash, so even after quarantining some to fund losses, you could argue the enterprise value is around $700m. That works out to be about 15x gross profit.
That isn’t cheap at all.
In FY 2024, gross profit was about $68m and net profit after tax was about $10m (albeit thanks in part to a low tax rate). That means net profit was about 14.7% of gross profit. This gives us an indication that the business can become profitable if it grows gross profit sufficiently. But it still doesn’t give us a solid basis for valuation.
Ultimately, the only way Audinate can succeed is through gross profit growth. Right now, the market is digesting the near certainty of a large setback to gross profit in FY 2025. That could bring back the USD gross profit growth to around 50% in 5 years, which isn’t really enough to justify the multiple.
On the other hand, if the company can achieve 50% growth on its peak gross profit of ~US$45 million, that would be around US$67.5 million. If that converts to profit at ~15% then that’s NPAT of ~US$10m or ~$15.4m AUD. In that scenario, profit growth rates would impress and likely more than justify an elevated P/E ratio, assuming the market extrapolates the growth.
I think due to the cyclicality of the business and the distortions caused by re-stocking and de-stocking, Audinate is going to have periods where it looks better than it is, and also periods where it looks worse than it is. Right now, I’d say we’re entering a period where Audinate looks worse than it really is, so that is why I want to buy shares. I believe I can make money from Audinate by buying when sentiment is low, and selling when sentiment is high.
I considered making Audinate an official buy recommendation, but ultimately I’m not going to because it doesn’t pass my leadership quality filter. As a result, I think of it more as a multi-year sociological trade idea than a long-term buy-and-hold-forever recommendation.
Audinate’s Leadership
The main reason Audinate does not pass my quality requirements to make it an official recommendation is that just over a year ago, the CEO Aidan Williams sold shares 10 days before a discounted capital raising. In my view, the capital raising seemed unnecessary (a the time), and it only made sense if the business was going to suffer losses in the near future. Sure enough, we now know (but did not know then) that FY 2025 will see a massive loss after a couple of years of modest profitability.
The CEO was paid just over $2m in remuneration over FY 2023 and FY 2024, but after the bad news about FY 2025 came out, the share price is basically flat over the last 2 years.
Not only did long-serving CFO Rob Goss quit in May this year, but it appears from the annual report that long-serving CFO Rob Goss sold his shares.
Notably, the directors and key management personnel above own less than 4% of the company, indicating low levels of alignment with shareholders. You can see that multiple directors sold shares multiple times in the leadup to the (initial) disappointing guidance in August, which turned out to be misleading optimistic, anyway.
Audinate had to downgrade the August guidance at the AGM in October. So there is no real reason to trust the latest guidance, and the market will be slowly losing respect for Audiante each time it has to downgrade its guidance.
Offsetting this somewhat, Audinate has historically made good decisions with regard to its growth strategy. This is borne out by Audinate’s success in making Dante the dominant audio networking protocol.
All in all, I do find Audinate shares attractive at current prices, but mostly as a sociological trade based on current negative sentiment. Given the fact Audinate has at least some degree of pricing power, I think it is more a matter of “when” results improve rather than “if” results improve. Once results (at near-term guidance) look more positive, I think sentiment around the stock will improve, and that is likely to drive the share price higher, despite the optimism already implicit in it.
When might I sell?
I note that the remuneration for executives would be maximised if the FY 2027 gross profit is particularly strong even if it meant sales were weak in FY 2028. Furthermore, I note that the remuneration will depend on the share price in the last week of August and first week of September. Therefore, the CEO will be incentivised to produce a strong FY 2027 result. If they are in a position to give positive FY 2028 guidance, the incentive is to produce the results sometime around the 20th to 23rd of August. If they are not in a position to give good guidance they would be incentivised to withhold results to the end of August.
As I understand it, the remuneration structure would create an incentive to get sales in June 2027 rather than July 2027 because the higher the FY 2027 result, the more the CEO will get paid. It is also possible that the LTI re-sets in FY 2028 (unknown). In that case a lower FY 2028 result might make it easier to achieve the next LTI.
Here is the relevant excerpt from the AGM notice:
Therefore, I would think that around the end of August 2027 might be a good time to reduce the position.
Disclosure: The author of this article Claude Walker already owns shares in Audinate. He will not trade Audinate shares for at least 48 hours following the publication of this article, but intends to buy some more after that. This article is not intended to form the basis of an investment decision and is not a recommendation. Any statements that are advice under the law are general advice only. The author has not considered your investment objectives or personal situation. Any advice is authorised by Claude Walker (AR 1297632), Authorised Representative of Equity Story Pty Ltd (ABN 94 127 714 998) (AFSL 343937).