The Audinate Group Ltd (ASX: AD8) share price has been an exciting name in the ASX tech space for quite some time.
Given the uncertainty of the future, are Audinate shares a buy at today’s levels?
AD8 share price chart
What does Audinate do?
Audinate is an Australian provider of professional digital audio networking technologies. Its flagship platform is called Dante, which enables the distribution of digital audio signals over local area networks (LAN) and essentially combines IT networking benefits to the professional audiovisual (AV) industry.
To someone without prior knowledge in this field, some of the underlying technology and applications might come across as fairly complex and esoteric. I am by no means a sound engineer, but I’ll attempt to explain the basic concepts of how this sort of technology can be used.
Dante can be used in various AV applications that involve multiple microphones, mixers, processors, amplifiers and speakers. Some common applications include live performances in stadiums, churches, lecture halls, ballrooms and radio stations.
Traditionally, connecting all the hardware would require multiple analogue cables that were costly and often cumbersome to manoeuvre. Dante simplifies this traditional process by replacing the old connections with a local area network using ethernet cables. The end result is a much easier setup that drastically reduces the amount of hardware needed to send audio between devices.
COVID-19 disaster
Audinate supplies its networking components to other manufacturers of professional AV equipment, including Yamaha, Bose and Sony. As such, its revenue is mainly driven by the volume of new pro-AV equipment being sold. To take this a step further, it really comes down to individual businesses’ capital expenditure that would involve this sort of equipment.
As you can imagine, COVID-19 has brought the majority of the gig economy to a standstill. As a result, stadiums aren’t being fitted out with new sound gear and lecture halls have been empty. Audinate’s FY20 results weren’t great, with pretty much flat revenue growth and a net loss of $4.1 million for the year.
While the decreased demand has halted sales growth, management has at least appeared proactive in response to the negative situation. The company undertook a $40 million capital raising in July and August with the funds to be used for R&D to develop new technology to take advantage of the COVID environment.
The company already had around $30 million cash prior to the raise and hinted towards potential M&A activity at some point, however, this hasn’t come to fruition yet.
V-shaped recovery?
Compared to the ASX travel shares that would likely see a rapid pick up in sales from a hypothetically successful vaccine, some have pointed out that Audinate’s recovery could be drawn out much longer in comparison.
The intuition does make sense here: for a struggling business that would usually buy sound equipment in favourable conditions, it doesn’t seem likely that large capital expenditures would be high on the priority list compared to other costs that could be considered more essential to the operations of the business.
If this does happen to be the case, it doesn’t seem likely that Audinate’s revenues and earnings are going to experience that V-shaped recovery that we’d expect in others. What could eventuate instead is a significant lag behind the rest of the economy. My guess would be that management thinks this as well, as it has suggested revenues are unlikely to grow in FY21.
Are Audinate shares too expensive?
For a company with such a grim outlook of the broader environment, I would’ve expected the valuation to be reflective of the situation. However, Audinate shares currently trade for around $7.80 at the time of writing, which is roughly 18x FY20 sales. This is by no means cheap, especially considering the most recent net loss of $4.1 million last financial year.
The market has clearly looked past this ongoing headwind and valued the company based on its future growth prospects in the long-term. I think this is partially justified given the attractive features of the business.
Keep in mind that Dante is now the industry standard for modern AV connectivity. Future success will partly come from a large network effect where manufacturers are almost forced into making their products Dante-enabled, as Dante further establishes itself as being the preferred connectivity method.
Additionally, the intellectual property behind the Dante technology and the high switching costs provides a significant competitive advantage over its competition.
Audinate: buy/hold/sell
The general consensus among commentators seems to be that Audinate’s valuation is stretched given the uncertain outlook for the company. I would agree, and for this reason, I’d be wanting to try and pick up some shares around the $5 to $6 mark.
I think it’s logical and likely that events will return to pre-COVID levels and even higher at some point in the future. However, if the recovery takes longer than expected and shares are too expensive now, the overall investment opportunity could seem less attractive to some.
For more share ideas, here are 3 ASX shares I’m really liking at the moment.
