Casa Systems: Waiting For Cable CapEx To Recover – Casa Systems, Inc. (NASDAQ:CASA)

Casa Systems (CASA) generates half of its revenue from the cable sector, but this hasn’t produced much growth as the sector is in retention mode.

Data by YCharts

The small recovery in revenue is optical and the result of the acquisition of NetComm which closed on July 1, 2019, and brought in $34.5M in revenue in Q3.

The shares have been in a funk with two disappointing results, in particular Q3:

Q3 results

These weren’t pretty, which becomes instantly obvious from the slide from the November 2019 IR presentation:

The bad Q3 results were the result of:

  • Shortfall in cable revenue
  • Shortfall in wireless backlog revenue recognition

With respect to the first, management argued that it still sees “purchasing appetite” but the timing for closing of certain larger orders was “more protracted than what they saw in previous quarters.”

Given the large guidance reduction for the year, we’re not quite convinced of that. It remains to be seen when that “purchasing appetite” will morph into actual purchases.

On the wireless backlog, management argued this (Q3CC):

On wireless, revenue recognition for a part of our wireless backlog was delayed, given that a few additional features were requested to be added to a product associated with one of our larger purchase orders. We see this as only a temporary delay, and in fact, we are already recognizing this revenue in the fourth quarter. This will be reflected in our Q4 results.

Again, this sits somewhat uneasy with the large decline in FY2019 guidance (see below), but can only be settled when we have sector figures from Q4.

Guidance

After the weak Q3, the company reduced FY2019 guidance quite significantly:

  • Revenue: $255M-270M (was $320M-350M)
  • Gross margin: 50-60% (ex NetComm 60-70%)
  • Adjusted EBITDA: $0-10M (was $40M-50M)
  • Non-GAAP EPS loss of $0.15-0.25 (was profit $0.20-0.30).

That’s quite a dramatic turn so it’s no wonder the shares sold off after Q3. However, on January 24, 2020, the guidance has been revived slightly to revenue at $275M-280M, with the rest of the guidance unchanged.

Growth

What’s perhaps a little underappreciated is the fact that the company has done a good job diversifying away from just cable, from the November 2019 IR presentation:

And this diversification opens up new, bigger and faster-growing markets, from the November 2019 IR presentation:

Its main position is still in cable, and management sees the present as just a lull, from the November 2019 IR presentation:

As the Q3 shortfall was mostly a result of the cable sector which is proceeding with the rollout of DAA (distributed access architecture). Here is what management argued (Q3CC):

Trials of DAA are progressing well, but we are not yet seeing moves to a large-scale deployment of DAA products. We continue to believe that deployments of DAA, including virtual CCAP, are inevitable. But we expect that DAA rollouts in the near term will be very measured, even in spite of early announced wins in this space.

So it will come, but the timing is unsure. What the company has been doing in the meantime is imposing a higher revenue threshold for trial qualification, and this has reduced the number of ongoing trials from 113 of 65 unique customers in Q2 to 87 trials with 52 unique customers in Q3, this to ensure proper return on investment and availability of resources.

The company remains well-positioned for when the orders arrive (Q3CC):

Given the unique breadth of our product portfolio, we believe that we continue to be very well positioned to meet our customers’ needs, no matter what infrastructure solutions they choose to deploy.

These solutions include integrated CCAP capacity, our new BDM cards, extended-spectrum DOCSIS, Remote PHY, Remote MAC-PHY as well as virtual CCAP. We think management has a point and the build-out will arrive, given the threat that 5G poses for cable companies.

Diversification

In the meantime, much of the growth has to come from other segments, from the November 2019 IR presentation:

And the acquisition of NetComm has given the company more exposure to these other segments, from the November 2019 IR presentation:

In fact, it’s not just NetComm’s product portfolio, it’s the combined product portfolio that is more appealing, from the November 2019 IR presentation:

So we can say that the acquisition of NetComm came at the right moment, with Casa’s core cable market undergoing a soft period.

The company was awarded best New 5G Technology at Broadband World Forum for its innovative converged 5G core solution. And there is some success with other wireless technologies (Q3CC):

we recently announced that Sprint has chosen Casa as a key indoor wireless solutions partner for a large-scale deployment of Casa Systems’ Pebble femtocell to improve data coverage and speeds in residences and businesses. The Pebble is the first femtocell from Sprint that offers an untethered Wi-Fi backhaul option as compared to the standard ethernet connection required in traditional femtocells.

Management also argued that while wireless products produced 9% (including access device business it was 26%) of revenue in Q3, this remains on track to reach 10-20% for FY2019. The backlog stood at $42M, of which $28M are new orders received during Q3.

Margins

ChartData by YCharts

The declining revenue is not the only factor producing notably lower margins, the NetComm acquisition also has a significant effect (roughly 10 percentage points of gross margin decline).

Cash

ChartData by YCharts

Cash flow also experienced a pretty dramatic turn for the worse and is now well into negative territory. The company ended Q3 with cash and cash equivalents of $124.6M and total debt of $293.8M. There isn’t much of a dilution problem and the company paid the NetComm acquisition in cash.

ChartData by YCharts

Valuation

Here is the surprising thing:

After peaking at nearly $35 in spring of 2018, the shares have fallen back to $4 and change, that’s quite a collapse. But it’s difficult to call the shares cheap, at least at the moment:

ChartData by YCharts

But cheap is a matter of opinion. SA contributor Leslie Harrison has produced a valuation exercise which assumes the company merely grows along with the industry, and he arrives at a $9 value.

We tend to agree with that perspective, which assumes quite an improvement in performance, supposedly when the CapEx cycle of DSOs and cable companies resumes. The timing of that is pretty uncertain, and in the meantime the shares are likely to struggle.

Conclusion

Based on past performance, the company is likely to experience a vigorous recovery when the DSOs and cable companies resume their CapEx. The latter is likely, as cable faces a competitive threat from 5G, it’s the timing that’s uncertain.

With the acquisition of NetComm, the company has also increased its exposure to other segments besides cable, and these are growing, but so far the company’s results have not reflected this all that much, and the acquisition has taken down gross margin by quite a bit.

In the end, we think that the upside is bigger than the downside, so we do think one can start accumulating at these levels – stock price recoveries usually run a couple of quarters ahead of the recovery in company financials.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any 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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