TD research today increase target to $18.00DragonWave Inc.
(DWI-T, DRWI-Q) C$13.38
Strong Results and Another Guidance Bump
Event
DragonWave reported better than expected Q3/10 results and increased its full year revenue guidance.
Impact
Positive. DragonWave’s Q3 results showed stronger than expected revenues and gross margins that beat our estimates and the Street. The company continues to see strong sequential growth with top customer Clearwire as it
builds its WiMAX network. The company also increased its F2010 revenue guidance well above expectations. We continue to like the story and feel the opportunities for new business at Verizon and AT&T help balance uncertainty
of orders with Clearwire beyond this calendar year. We have increased our target to $18.00 from $14.00 previously.
Details
DragonWave posted strong Q3/10 results. Revenue of $55.8 million again showed strong sequential growth, up from $35.5 million last quarter. The sales result exceeded our $50.0 million estimate and the $49.3 million consensus. Gross margin was strong in Q3 at 42.9% vs. our 40% estimate. Operating expenses were slightly below our estimates in dollar terms and better than we had expected in percentage terms. DragonWave posted
.37 in EPS, significantly better than our
.23 estimate and the consensus of
.24.
The company increased its full year revenue guidance – again Management now expects revenues of approximately $170 million for F2010 (February end). This represents another increase, and is up from the prior guidance of more than $150 million following the Q2/10 results. The full year revenue guidance implies Q4/10 revenues of about $63 million. Before the Q3/10 results, we had been modeling $56.0 million and the consensus was $53.9 million, so the positive surprise was more than just a strong Q3.
Other key points from the quarter:
• Verizon and AT&T represent growth opportunities. Verizon is in the process of deploying LTE and AT&T has publicly discussed investments in its wireless backhaul network. We believe both are considering the use of microwave Ethernet technology. DragonWave is competing for business with each carrier and we believe stands a good chance to win a share of microwave orders. We would not expect any revenue from either AT&T or Verizon until later on this year.
• Clearwire business should remain strong through September, but visibility beyond that is less certain. Clearwire’s stated goal is to reach 120 million POPS under coverage by the end of C2010. On the conference call, DragonWave management suggested that gives them pretty good visibility to about the end of September. However, activity with Clearwire beyond September will depend on how aggressively the carrier plans to expand coverage beyond those initial 120 million POPS. In our view, this represents risk in the second half of DragonWave’s F2011. The company may need to win business with AT&T or Verizon in order to maintain its current growth trajectory if Clearwire revenues begin to fall off.
• DragonWave is optimistic about opportunities in international markets. In many cases, these are theatres that the company has not competed in, or has underserved, in the past. The company has increased its presence in Mexico and Latin America, and recently won a deal in Cost Rica. Microwave has traditionally been a popular choice for European carriers, and the region could represent a significant opportunity for DragonWave as service providers deploy LTE. DragonWave is also turning more of its focus to India and China for their 3G builds.
• Microwave backhaul makes a strong capex case for suburban coverage. In most North American cities, the downtown core already has significant fiber in the ground, making it the natural choice for backhaul in those areas. We’ve heard comments from AT&T along these lines. However, when you move out to the suburbs, the deployed fiber is less dense. DragonWave management believes that the tipping point for the capex decision to backhaul a base station with either fiber vs. microwave is at a distance of about ½ a mile from a fiber connection. We believe there will be more opportunity for microwave as carriers address their suburban coverage where fiber is less plentiful.
• DragonWave’s technology has technical advantages over its peers, in our view. Notably, we believe
that DragonWave has designed its products with higher capacity than competing products and its alloutdoor
solution is very popular. DragonWave is also developing products incorporating real-time compression, which the company hopes to reach commercial availability in its Q1/11.
Outlook
We have increased our estimates. We have increased our revenue estimates on DragonWave’s strong F2010
guidance. We continue to model gross margins of 40%, in-line with the company’s long-term model. Management expects gross margins to normalize towards this level in Q4/10. If margins were to sustain around Q3/10’s level, it could represent upside from our estimates. We have also reduced our tax rate assumptions for F2011, as management believes it has tax shelters for about $60 million. As a result of these changes, we have increased our EPS estimates to
.85 in F2010 (was
.65 previously) and $1.09 in F2011 (was
.72).
Our $18.00 target price is based on a 16-18x multiple of our F2011 EPS estimate. We also maintain a DCF
model to act as a sanity check. We have reduced the P/E range we use to 16-18x from 18-20x due to what we see as the uncertainty of growth once Clearwire completes its initial build-out plans later this year and to adjust for what we believe to be an unsustainably low current tax rate.
Key Risks to Target Price
Key risks to our target price include: 1) Key carrier relationships and customer concentration; 2) Carrier capital spending; 3) Adoption and deployment of 4G wireless technologies; 4) Ability to maintain current product portfolio; 5) Ability to maintain/win share; 6) Pricing environment; 7) Intellectual property disputes; 8) Reliance on manufacturing partners; 9) Value of the Canadian dollar.
Investment Conclusion
DragonWave continues to deliver strong growth through its business with Clearwire. We have increased our target to $18.00 and could see further upside if the company were to win significant new business with AT&T or Verizon.