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Vislink — Update 28 July 2016

Vislink — Update 28 July 2016

Vislink

Analyst avatar placeholder

Written by

Vislink

Fast-forward on transition to software

Trading update

Tech hardware & equipment

28 July 2016

Price

16.88p

Market cap

£21m

Net debt (£m) at end December 2015

5.7

Shares in issue (excluding 2.0m shares issued to satisfy exercise of options, anticipated admission 2 August 2016)

122.6m

Free float

90.3%

Code

VLK

Primary exchange

AIM

Secondary exchange

N/A

Share price performance

%

1m

3m

12m

Abs

(46.0)

(54.7)

(70.1)

Rel (local)

(52.3)

(57.1)

(71.0)

52-week high/low

55.8p

10.6p

Business description

Vislink is a global technology business specialising in the collection and delivery of high-quality video and associated data from the field to the point of usage. These are used in the broadcast, surveillance and public safety markets.

Next events

Interims

September 2016

Analysts

Anne Margaret Crow

+44 (0)20 3077 5700

Dan Ridsdale

+44 (0)20 3077 5729

Vislink is a research client of Edison Investment Research Limited

Vislink has announced that FY16 performance will be materially below previous estimates because of weakness in the hardware division (VCS). Management has instigated a restructuring of this division, accelerating the transformation of the group into one where two-thirds of operating profits are derived from software activities. Progress executing this transformation should prompt a partial recovery in the share price.

Year
end

Revenue (£m)

PBT*
(£m)

EPS*
(p)

DPS
(p)

P/E
(x)

Yield
(%)

12/14

61.9

7.6

5.1

1.5

3.3

8.9

12/15

57.8

4.4

2.9

1.5

5.8

8.9

12/16e

50.5

3.6

2.2

0.8

7.7

4.4

12/17e

52.3

4.4

2.7

0.8

6.3

4.4

Note: *PBT and EPS are normalised, excluding amortisation of acquired intangibles, exceptional items and share-based payments.

VCS division underperforming

VCS sales during H116 were below management expectations for a combination of reasons discussed later, which were specific to this division. Management expects this divisional underperformance to continue into H216. In addition, H116 sales from the software division, Pebble Beach Systems (PBS), were below management expectations, though since this was related to contract decisions slipping from Q2 to Q3, and activity levels are strong, management expects the division to meet its expectations for the full year. We revise our estimates accordingly.

Acceleration of transition to software and services

Recognising structural changes in the global broadcast industry management had already prioritised investment on PBS and cut VCS costs. In response to the H116 issues, management is substantially accelerating this transformation, initiating a radical restructuring of VCS and streamlining the hardware product portfolio. This is expected to result in annualised cost-savings of £1-2m (we model £1.0m, primarily benefiting FY17) and a £6-9m non-cash impairment of IP and write-down of inventory (we model £8.0m total exceptional costs, falling in FY16). Management is also reviewing the dividend policy with a view to conserving cash.

Valuation: Post restructuring upside

We expect the group to emerge in a much better shape following the extensive VCS restructuring. With a greater proportion of revenues derived from the software division, the group should benefit from higher gross margins, better earnings visibility and better cash conversion. Crucially, investment will be focused on those sectors which are actually benefitting from the cost pressures affecting the global broadcast industry, ie, software for broadcast contribution and hardware for IP-based content transmission over private networks. Newsflow confirming that the restructuring programme is succeeding should prompt a partial recovery in share price to our indicative value of 22p (previously 54p).

Changes to estimates

Exhibit 1: Changes to estimates

FY15

FY16e

FY17e

Actual

Old

New

% change

Old

New

% change

VCS revenues (£m)

46.9

47.3

38.8

-18.0

48.3

39.8

-17.6

VCS EBITA (£m)

2.8

5.2

1.0

-80.8

5.3

2.0

-62.3

PBS revenues (£m)

10.9

11.7

11.7

0.0

12.5

12.5

0.0

PBS EBITA (£m)

3.3

3.5

3.5

0.0

3.8

3.8

0.0

Group revenues (£m)

57.8

59.1

50.5

-14.6

60.8

52.3

-14.0

Group adjusted PBT – before deducting share-based payments (£m)*

4.4

6.9

3.6

-47.8

7.3

4.4

-39.7

Share-based payments (£m)

0.0

(0.6)

(0.6)

0.0

(0.6)

(0.6)

0.0

Group adjusted PBT - after deducting share-based payments (£m)

4.4

6.3

3.0

-52.4

6.7

3.8

-43.3

Adjusted EPS – before deducting share-based payments (p)

2.9

4.2

2.2

-47.6

4.4

2.7

-38.6

DPS (p)

1.5

1.5

0.8

-50.0

1.5

0.8

-50.0

Source: Edison Investment Research. Note: *This is Edison’s normalised PBT.

The key changes we have made to our estimates are:

■

Reduction in VCS revenues and associated reduction in VCS operating profit.

■

Reduction in VCS operating costs following restructuring programme.

■

Reduction in central costs, as the Brexit-induced fall in sterling against the dollar is expected to result in a significant forex translation benefit during FY16.

■

Adjustment of dividend to reflect lower profits.

■

Inclusion of £8.0m exceptional costs for FY16 relating to IP and inventory write-downs and one-off restructuring costs.

Strategy – emerging stronger after radical restructuring

Bringing out the best of the hardware division

Discussion with management suggests that the main reasons why VCS H116 revenues were lower than expected were specific to that division. Some new products were launched later than expected. There were delays in deliveries of some of the older satellite communications products because of issues with a supplier that have now been resolved. Demand from the surveillance sector, which has always been volatile because of the large scale of some of the projects worked on, was weak. Finally, demand from the Middle East was lower than has been the case historically because the low oil price has reduced the cash available for investment.

While some of these issues have been fixed, the market environment for broadcast contribution businesses such as VCS continues to be difficult. Broadcasters are experiencing severe pressures on costs because of the movement of advertising expenditure from TV to online formats. While VCS products such as miniaturised camera transmitters help broadcasters create compelling content that will attract larger audiences and advertising income, they are essentially discretionary in nature, so sales are vulnerable in a downturn. Management estimate that the broadcast hardware market shrank by 10-15% during FY15. Equipment that helps broadcasters cut costs is doing better. Where possible, established broadcasters are shifting content transmission from traditional microwave and satellite links to IP-based networks. VCS has introduced several ranges of products to address this trend.

In response to the structural changes in the market, management is implementing a far-reaching restructuring programme of the hardware division. This involves more than simply cutting costs. It is about taking a hard look at the product portfolio, prioritising investment on the equipment needed as the broadcast contribution industry transitions to IP-based transmission, and culling legacy technology. It is early days, but the IP-based transportation methodology may involve software solutions for these new networks.

Software to drive growth going forward

PBS is in a different sector of the broadcast market to VCS. it is actually benefitting from the cost-pressures on the global broadcast industry as these are causing the broadcast distribution paradigm to shift from processing content using dedicated hardware to processing content using specialist software hosted on standard hardware located either at the broadcaster’s premises or in the “cloud”. Demand for PBS’s products is therefore growing. Broadcasters are under pressure to launch new channels that will potentially attract niche advertising budgets. These cannot be launched without playout software, so PBS products can therefore be regarded as mandatory in nature. Moreover, PBS is a relative newcomer on the global stage with plenty of scope for gaining sales through partnering with Harmonic, a major North American supplier of broadcast distribution hardware.

At the full year results presentation in March, management stated that PBS, though substantially smaller than VCS, was the growth engine for the group and where investment would be prioritised going forward. The ongoing restructuring of the VCS division accelerates this transition.

Valuation: Significant upside at current levels

Exhibit 2: Multiples for listed peers

Company

Market cap (£m)

Current EV/Sales (x)

Next
EV/Sales (x)

Current EV/ EBITDA (x)

Next EV/ EBITDA (x)

Current P/E
(x)

Next P/E
(x)

Cobham

£2,866m

-

-

-

-

12.9x

12.7x

Comtech Telecommunications Corp

£242m

0.4x

0.3x

3.8x

2.4x

-

46.5x

Evertz Technologies

£725m

2.8x

2.6x

9.7x

8.7x

15.5x

13.4x

EVS Broadcast Equipment SA

£354m

3.2x

3.2x

9.5x

10.3x

14.7x

16.1x

Harmonic Inc

£185m

0.5x

0.4x

5.4x

2.3x

54.5x

11.4x

Harris Corp

£8,179m

2.1x

2.1x

12.4x

9.6x

15.2x

14.8x

PC-Tel Inc

£63m

0.5x

0.5x

6.5x

5.0x

19.6x

13.0x

ViaSat Inc

£2,751m

3.0x

2.8x

12.7x

12.0x

62.8x

69.2x

Vitec Group

£238m

-

-

-

-

9.7x

9.3x

Mean

 

1.8x

1.7x

7.0x

6.4x

14.6x

13.0

Vislink (16p)

£13m

0.5x

0.5x

3.4x

3.1x

7.3x

5.9x

Vislink (indicative share price of 22p)

£27m

0.6x

0.6x

4.3x

4.0x

9.9x

8.2x

Source: Bloomberg, Edison Investment Research. Note: Prices at 23 July 2016. Grey shading indicates exclusion from mean.

The stock extended its underperformance following the trading update, leaving the shares trading at a substantial discount to listed peers on all metrics. Clearly, the uncertainty created by the ongoing restructuring programme makes it inappropriate to make a direct comparison between Vislink and its listed peers; however, we believe that the share price will recover. Management is already reshaping the VCS division. It is reviewing the future dividend policy so as to conserve cash without jeopardising continuing investment in product development.

At the end of this process, we expect the group to emerge in a better shape. A higher proportion of revenues will be derived from the software business, giving higher gross margins, better earnings visibility and, medium-term, better conversion of operating profit to cash. Importantly, a higher proportion of the group’s capital will be invested in the software division, which not only has the potential for delivering better margins than VCS, but has superior growth prospects. The hardware division will have a smaller cost-base and a product portfolio closely aligned to the rapidly changing market requirements.

Once this transformation has been achieved, it will be reasonable to revert to the valuation methodology based on comparative share price multiples with the caveat that other stocks in our sample are exhibiting significant share price volatility. Our indicative share price of 22p (previously 54p) places Vislink in the same ball park as the listed peers, while providing a discount to reflect lower EBITDA margins (17.7% 2016 mean vs 14.9% for Vislink; 19.7% 2017 mean vs 15.7% for Vislink). We expect this margin gap to erode with time as the software division contributes an even greater share of group profits. We note that at our indicative valuation of 22p/share, the market capitalisation of the group would be £27m, which we calculate is 13.5x the 2016 profit after tax the group might generate from the software division, while ignoring any incremental profits from the VCS division. In effect, therefore, our indicative valuation treats any profit contribution from VCS as upside.

Newsflow confirming that the restructuring programme is succeeding and that the delayed PBS orders have finally come in should prompt an upward revaluation of the shares. Alternatively, since the current market capitalisation is also substantially below the net asset value at end 2015 (£54.5m), even taking into consideration the £6-9m write-downs noted by management, the possibility of participating in any industry consolidation may provide further opportunity for unlocking of value.

Exhibit 3: Financial summary

£m

2014

2015

2016e

2017e

Year end 31 December

IFRS

IFRS

IFRS

IFRS

PROFIT & LOSS

Revenue

 

61.9

57.8

50.5

52.3

Cost of Sales

(33.5)

(31.8)

(26.4)

(27.0)

Gross Profit

28.4

26.0

24.2

25.3

EBITDA

 

10.7

8.7

7.5

8.2

Operating Profit (before amort and except)

 

7.7

4.7

3.8

4.5

Amortisation of acquired intangibles

(2.6)

(2.4)

(2.4)

(2.4)

Exceptionals

0.9

(3.1)

(8.0)

0.0

Share based payments

(0.5)

0.0

(0.6)

(0.6)

Operating Profit

5.5

(0.8)

(7.2)

1.5

Net Interest

(0.1)

(0.2)

(0.2)

(0.1)

Profit Before Tax (norm)

 

7.6

4.4

3.6

4.4

Profit Before Tax (FRS 3)

 

5.4

(1.0)

(7.4)

1.4

Reported Tax

(1.6)

0.1

0.0

(1.1)

Profit After Tax (norm)

6.0

3.5

2.7

3.3

Profit after tax (FRS 3)

3.7

(0.9)

(7.4)

0.3

Average Number of Shares Outstanding (m)

117.8

121.9

122.6

122.6

EPS - normalised (p)

 

5.1

2.9

2.2

2.7

EPS - normalised fully diluted (p)

 

5.1

2.8

2.2

2.6

EPS - (IFRS) (p)

 

3.2

(0.7)

(6.0)

0.2

Dividend per share (p)

1.50

1.50

0.75

0.75

Gross Margin (%)

45.9

45.0

47.8

48.4

EBITDA Margin (%)

17.2

15.0

14.9

15.7

Operating Margin (before GW and except) (%)

12.4

8.1

7.5

8.5

BALANCE SHEET

Fixed Assets

 

50.1

49.0

45.1

43.4

Intangible Assets

43.7

42.3

38.9

37.8

Tangible Assets

2.7

2.2

1.7

1.2

Deferred tax assets

3.7

4.5

4.5

4.5

Current Assets

 

37.2

34.7

25.8

27.8

Stocks

12.9

12.7

6.7

7.7

Debtors

16.0

18.8

18.0

17.2

Cash

8.4

3.3

1.0

2.8

Current tax assets

0.0

0.0

0.0

0.0

Current Liabilities

 

(22.4)

(23.1)

(19.5)

(19.8)

Creditors

(16.8)

(14.1)

(10.5)

(10.8)

Short term borrowings

(5.6)

(9.0)

(9.0)

(9.0)

Long Term Liabilities

 

(8.0)

(6.1)

(6.1)

(6.1)

Long term borrowings

(2.4)

0.0

0.0

0.0

Other long term liabilities

(5.6)

(6.1)

(6.1)

(6.1)

Net Assets

 

56.8

54.5

45.2

45.2

CASH FLOW

Operating Cash Flow

 

8.0

0.6

4.1

7.8

Net Interest

(0.1)

(0.2)

(0.2)

(0.1)

Tax

(0.1)

(0.9)

0.0

(0.5)

Capex

(4.6)

(3.8)

(4.3)

(4.5)

Acquisitions/disposals

(7.0)

0.0

0.0

0.0

Financing

2.0

(0.0)

0.0

0.0

Dividends

(1.5)

(1.8)

(1.8)

(0.9)

Forex

(0.0)

0.0

0.0

0.0

Net Cash Flow

(3.3)

(6.1)

(2.2)

1.8

Opening net debt/(cash)

 

(3.7)

(0.4)

5.7

8.0

HP finance leases initiated

0.0

0.0

0.0

0.0

Other

0.0

0.0

0.0

0.0

Closing net debt/(cash)

 

(0.4)

5.7

8.0

6.2

Source: Edison Investment Research, Vislink accounts

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