Thesis
in this article, I'm rating wireless equipment company, Ubiquiti (NYSE:UI) as a hold despite the stock losing almost 60% (YoY), and I expect it to reach its fair value within two years; since it is undertaking an ambitious roadmap towards improving its enterprise technology including its gateway devices and security of its wireless products that will add revenue in the long run.
Q2 2024 saw new product launches including the Unifi Express (home network devices) which according to my analysis have always led to subsequent revenue increases. On the management side, Ubiquiti has an impressive business structure with a minimal sales force (mostly distributors), system engineers, and the CEO. This model in the long run will leave a substantial cash balance for research and development (R&D) which is the core of the business. The company is also increasing its direct sales to both distributors and customers especially on its e-commerce platforms as they maintain disruptive prices that help keep up with the competition.
Ubiquiti Inc. was founded in 2005 and the stock has surged +170% over the last 10 years. It has shot more than +500% since it went public in 2011 for $15 per share. As of this writing, the stock is trading 57.61% below its 52-week high of $269.40 but well within the value area for a rebound due to its fundamentals.
Growing Networking Technology
Since inception, UI has been releasing novel products on a regular basis with an aim of keeping up with the networking industry while growing its product line. In terms of its wireless technology, the company first began with the "SuperRange3 Mini-PCI wireless module" (SR3 card) limited to a frequency bandwidth of up to 3.6 GHz to the UniFi 7 reaching up to 6 GHz.
Ubiquiti’s main revenue sources include Unifi’s enterprise products (UniFi) and service/ software provider technologies such as airMAX and UFiber etc. There are many special aspects with Ubiquiti’s products such as the power over Ethernet (POE) features, affordable switch capabilities that are deployable and scalable. There is also the UniFi switches which have been built to process and visualize heavy traffic. UI’s products still maintain network efficiency during performance.
Ubiquiti has over the years, developed and diversified its product line as follows:
Ubiquiti makes its money primarily from hardware sales and post-contract services (PCS) as opposed to selling software or earning rights from licenses. These devices include networking switches, cameras, security gateways (for large and small enterprises) wireless access points (WAPs), etc. Back in 2018, Ubiquiti’s CEO Robert Pera explained that the company was expanding its UniFi (access point) from just a WiFi aspect to a networking ("WLAN") solution complete with security and other advanced features.
With this expansion, annual revenues in FY 2018 jumped 17.5% (YoY) hitting more than $1 billion for the first time. Revenues from UniFi enterprise technology accounted for more than 50% of this amount at $570.3 million.
The year 2019 saw the launch of the UniFi Dream machine (UDM) a gateway router (1Gbps) built with a firewall and a network application. Ubiquiti advanced to UDM-Pro, SE, and Dream routers later in 2022, but it still could not be integrated into an exterior cloud key for UniFi. However, with advanced features such as 4-port switches/ 4K cam protection, and Wi-Fi6 among other upgrades, revenues jumped to $1.2 billion in 2019 and later to $ 1.7 billion by FY 2022. As of the FY ending on June 2023, Ubiquiti’s revenue had reached $1.88 billion, despite the 3.3% (YoY) decline.
By the beginning of 2024, Ubiquiti had launched the UniFi Express which it describes as a "Powerfully compact UniFi Gateway and WiFi 6 access point that runs UniFi Network.” Another aspect is its ability to be converted into a mesh system allowing the user to expand the wireless network. It is also flexible to the point of being added to an existing network or simply run in an “Access Point Only Mode.” With its thousands of customers, the UniFi Express can be a seamless fit within their current networks. Other new products include the U7 Pro, U6 Enterprise, and the U6 Enterprise In-Wall- all with a ceiling-mountable feature. Except for the U7 Pro that has WiFi 7 AP, the other two have “WiFi 6E AP but with 10 spatial streams and 6GHz support) instead of 6."
I assume that Ubiquiti is expected to realize additional revenue into 2025 owing to the increased number of new product launches in 2024. UI’s revenue in Q2 2024 dropped 5.8% (YoY) to $464.95 million from $493.57 million in 2023. However, since Ubiquiti gets its revenue from hardware sales, the more the launches, the greater the revenue.
Ubiquiti’s pricing of its UniFi products seems very competitive as compared to other related products out in the market. First of all, the UniFI Express described earlier, with its combined routers and WiFi (access point aspect) goes for $149. All a customer needs to do after purchase, is just to add Ethernet (and they are good to go). UI's wireless competitor, the Cisco Meraki MR36 goes for $414, while the Cisco CW91621 costs $833.55. The Extreme WiFi6 (Access point) costs $376 meaning that the price difference (with UniFi Express) is more than 100%.
Lean Organization Structure
Ubiquiti's management is primarily composed of the CEO, system engineers, and a few personnel thereby eliminating bureaucratic operations. With a lean business process, the company has been able to save on operational costs. UI’s selling general and administration (SG&A) have stood below $100 million since its founding while its total annual operating expenses have all been under $230 million despite revenues rising to $1.9 billion in the past year.
Despite having a cash balance of $97.7 million (in the FY 2023) which was a decrease of 15% (YoY) from the previous year, UI managed to reduce its cash used in operations by more than $146 million in the FY 2023.
To save on sales force costs, UI uses a robust network of distributors as well as its e-commerce site to supplement its income. However, it is worth noting that UI has been re-engineering its e-commerce sites so that it may also increase direct sales to its customers without relying on third parties. In the 6 months ending in December 2023, the income from sales distributors “accounted for 64% of its revenue” while e-commerce sales took 36%. In the fiscal year ending in June 2018, UI's "sales to distributors" contributed 99% of its revenues.
The company has also increased the number of warehouses under its operations over the past 5 years. From a single warehouse in Utah, US (and an order fulfillment location in China) to multiple warehouses spread across the “US, Europe and Asia Pacific.” What's more, UI has added another order fulfillment site in Vietnam, alongside China to bolster its supply chain and improve its operations with contract manufacturers.
Risks
Poor support and singular management
UI’s CEO, Robert Pera remains the singular decision maker for the company. Aside from system engineers, the company also lacks an adequate sales force. This situation means the management lacks a robust support team to handle operations. In its Q2 2024, 10-Q Ubiquiti underscored that instead of relying on the "traditional direct sales force" it maximizes on the use of “online reviews and publications.” To some extent, this directive means lower expenditures, but on the other hand, it reduces the company's ability to locate practical/ deployable solutions within its products.
Additionally, there needs to be expanded management to help the CEO Robert Pera in service delivery. There is a risk that his absence or inability to perform his functions as CEO may hinder the company’s progress.
Signal Jamming
Ubiquiti needs to increase security features in its UniFi enterprise systems to prevent signal interference or interference. This comes in the wake of reports indicating Canada could be planning to ban the access control/ hacking system- Flipper Zero. Despite its potentially dangerous features, Flipper Zero’s main attributes like the replaying of digital radio frequency communication can be used to improve overall system security. Since Ubiquiti’s UniFi is a network of wireless access points ("WANs") it can also be compromised by hackers to infiltrate routers and other connected devices. Such reports call for added security to prevent cyber-attacks on UI’s enterprise technology.
Debt and Interest Rates
Ubiquiti's total debt stands at $1.05 billion which it explained in its recent 10-Q is exposed to the variations in interest rates. Ubiquiti stated and I quote,
Based on a sensitivity analysis, as of December 31, 2023, an instantaneous and sustained 200-basis-point increase in interest rates affecting our floating rate debt obligations, and assuming that we take no counteractive measures, would result in an incremental charge to our income before income taxes of approximately $19.9 million over the next twelve months."
Such a situation may augment the interest expense which is already growing as seen in the financial statement below.
UI's interest expense accounted for 4% of the company's revenue in Q2 2024 and in the 6 months ending on December 31, 2023 and about a third of its total operating expenses. The company also stated in its 10-Q that it had a revolving facility (a variable credit line) balance of $375 million which may be affected by the varying rate hikes.
The other catch is that the company has a cash balance of $97.7 million against its debt portfolio of $1.05 billion. It leaves off a negative cash balance of about $952.3 million (in the eventful case the cash will be used in deleveraging).
Valuation
To assess UI's fair value, I will use the stock's price to earnings (P/E ratio). This ratio is important as it will help in understanding the market value of UI while also considering its past/ historical performance against its earnings potential. UI's forward P/E ratio stands at 16.56 against the industry average of 28.14. This leaves out a difference of -41.15%. It is likely that investors will be willing to pay 40% more at this time for UI, meaning the stock could rise above $160 in a year. There are a number of reasons why I think, UI will have a price return growth above 40% in the long run.
Firstly, historical performance has shown UI's average annual growth rate in the past 5 years hit a high of 91% in 2019. It rose by 40.69% in 2018, +48.49% (YoY) in 2020 and +10.83% in 2021. In the 3 years from 2018 to 2020, UI outperformed SPY (as shown below).
In fact, the year 2021 saw UI hit its record high of $389 indicating strong momentum at the time.
In support of positive historical performance Ubiquiti is looking to increase its future earnings through high product development that will have a direct impact on the stock's market value.
UI's earnings per share ("EPS") or profitability have a direct correlation with the growth of the stock's price return. As explained earlier in the article, product development and expansion were the core pillars of the company's growth throughout the years especially from 2018. However, the company explained in its Q2 2024 10-Q that it has continued to face the risk of supply constraints as a result of the Covid19 pandemic. UI has contract manufacturers in China and Vietnam with the latter largely affected by lockdowns.
Further, given that we are in a high-interest rate environment (5.25%-5.5%), I believe UI will maintain or raise the product prices. This will translate to higher revenues and income for shareholders. Already, UI had reduced the cash used in operations from $145.4 million in FY 2023 to $1.5 million in 2024 (TTM) indicating it is getting back to generating cash from its operations into 2025.
Another aspect to consider is the annual dividend yield that stands at 2.03% ("FWD") against an annual payout of $2.40. My take is that UI will continue investing in growth opportunities since it has a low payout ratio of 38.52%. All the while, it will be stabilizing its cash flows.
Bottom Line
I have proposed a hold rating for UI in this article although I expect the company to attain its fair value based on successful product development, quality and deployment within two years. The stock has lost almost 60% (YoY) and I perceive market overreaction that may lead to further decline in the near term. I have considered that while Ubiquiti’s new product offerings are competitive owing to their expected performance and sale price, there is need to assess their deployment within the market in the FY 2024, seeing they are new products. Their impact on revenue will be important to consider in the next 6 months to 1 year. Other aspects I have also considered in the article, is their weak cash position against debt and ongoing supply chain risks. Still, the company has worked to lower its operating costs while increasing revenues over the years. Ahead of its Q3 2024 earnings release, I will be looking to see how the company is working to increase sales from both the distributors’ and e-commerce segments. I will also be looking to see how they have increased their cash position since it is a matter of concern especially with the low cash generated from operations. My take, is that this stock is worth watching ahead of its Q3 2024 earnings call.
Stella Mwende
I have more than five years experience in the financial industry. I focus mostly in the commodities, foreign exchange and cryptocurrencies. I also write on general issues like equity research, economics and geopolitics.Fellow contributor Crispus Nyaga is my colleague.
Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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