FARO Technologies: Not Living Up To Its Promises (NASDAQ:FARO)

It has been 2015 since I have last looked at shares of FARO Technologies (NASDAQ:FARO), a time when I concluded that speculative appeal was luring after a huge sell-off. In the years that followed, FARO has been seeing lackluster performance, albeit accompanied by spectacular share price performance at times. With the company not living up to its positioning, the question is if the appeal is luring now at much lower levels, something on which I have serious doubts.

Some Background

FARO is a 3D tech firm which benefits from a number of long-term secular growth trends. The company develops and sells computer-aided measurement devices and software, essentially sophisticated measurement machines which can be used in a wide range of applications.

These applications are used for prototyping, industrial applications, inspections, reverse engineering, and other applications. An increase in focus on quality, digitization and other trends should provide long-term growth.

When I last looked as FARO in 2015, the company operated with a net cash position of $174 million, as the 17.5 million shares traded around $46 per share. This translated into an equity valuation of $805 million, or $630 million if we back out net cash. This valuation was equivalent to 1.8 times anticipated sales of around $350 million and 18-19 times earnings, which topped $30 million.

Those looked like reasonable multiples, despite some softness that year, as the company has seen solid growth on the back of its positioning in the past. The company grew sales by a cumulative 175% in the decade up to 2015, albeit offset by some 20% dilution of the shareholder base, in itself offset by growing net cash balances.

What Happened?

To answer the question, we really have to define which time period we are looking at. After all, a $46 stock in 2015 fell to the low twenties in 2016, recovered to the $60s in 2018, as shares nearly rose to the $90 mark in 2021. Ever since then, it has been pretty much all downhill to $30 at this point in time, marking huge volatility in recent years, with real swings seen to both the upside and downside.

Fast forwarding to early 2020, we see FARO having posted the 2019 results, which were not too pretty. Sales fell to the mid-single digits to $382 million, marking just 10% cumulative growth in 2015. Lack of revenue growth, for years now, meant that the company already saw operating earnings fall to $6 million in 2018. The company posted a $59 million loss in 2019, and even if we exclude a $35 million impairment charge, substantial losses were still posted. The share count of 17.4 million was rather stable, with net cash posted at $158 million following some M&A action in recent times.

2020 sales fell to just $304 million as operating losses were posted at $31 million, half of which was explained by restructuring costs. Cash and equivalents rose to $185 million, despite the modest loss as this can in part be explained by modest dilution.

It turned out, 2021 revenues recovered in a modest fashion to $338 million as operating losses of $8 million were entirely explained by restructuring costs. Following a big tax bill, net losses were substantial as net cash balances fell to $122 million as again some dilution has been incurred, as otherwise operating performance was quite flat.

Given this background, I am surprised to see shares holds up well and trade at their highs in 2021 as revenues have been flattish or down for 7 years now, despite a good positioning. Moreover, solid profitability has turned into flattish or even negative earnings, as net cash balances are down a bit and over time some modest dilution has again been incurred.

Day Of Reckoning

Since the start of the year, valuations of the shares have come down a great deal, with shares now down to $30 as the market seems to recognize that there is much work to do. This is obviously seen in the results as well with revenues in the first half of the year down about 1% to $156 million, yet operating losses have more than doubled to $16 million. With again modest dilution incurred and net cash down to $102 million, this is not too worrying in the near term, yet it is worrying from a valuation point of view. Right now, the current market valuation stands at $550 million, or about a hundred million less if we factor in net cash.

Despite, or in spite, the operational challenges, FARO announced the purchase of UK-based GeoSLAM early in September. The company is set to add nearly GBP 15 million in revenues and early GBP 3 million in EBITDA. A GBP 22 million upfront payment and nearly half a million shares forked over to the previous owners make for a GBP 35 million deal tag, which looks fair and comes in at 7% of the value of FARO here.

The question is of course if M&A is the right way to go given the position in which FARO finds itself, and that modest dilution now is well-timed. The truth is that FARO has been struggling for years, despite the good positioning. Betting on a turnaround or M&A could make sense given the low sales multiple, but that is a bet as the operational performance has been dismal for years, with no real green shoots in sight. Amidst all of this, I reckon the potential, but recognize that the company itself has real struggles to ignite this potential, leaving me very cautious here.