Since the IMO issued its first global mandate for the use of AIS on all ocean-going vessels weighing over 300 tonnes gross, and all passenger ships regardless of size in 2002, AIS has become the technology of choice to enhance maritime domain awareness (MDA) across the world. In particular, the technology is used for vessel tracking; anti-collision; search and rescue; waterway, port and coast security; pollution monitoring; and fisheries management. Before 2002, maritime border security had largely been driven by radar, a technology that was first developed in the 1940s and which remains the primary onboard method of preventing collision.
But the information transmitted by AIS - vessel type, current co-ordinates, course and speed, and the vessel's unique identifier - means that both the coastguard and law enforcement agencies can accurately plot the co-ordinates of any seagoing vessel equipped with the technology. For instance, AIS can be used to battle contraband and drug trafficking, or monitoring fishing boats operating within permitted areas. To see how this operates in practice, browse marinetraffic.com, a website that plots the co-ordinates and courses of vessels fitted with AIS.
And the potential market for AIS is huge. According to experts, of the 26m vessels operational globally, 18m are leisure boats and 8m are commercial, of which 4m are fishing boats. So as more authorities across the world force vessels operating in their waters to fit AIS as standard, then the market for the technology can only grow. And that's why I have been taking a very close look at Aim-traded Software Radio Technology (SRT: 31.25p), a provider of MDA technologies and a small-cap company with a market capitalisation of £40m.
A bumper trading update
What sparked my attention was last week's trading update from the company, which revealed that Software Radio now has 21 validated fleet-monitoring project and mandate sales opportunities worth a potential of £200m in revenues. These projects vary in scale from the recently announced AIS mandate in Mauritius, worth an estimated £250,000 over the next year, to national vessel-tracking projects in the Middle East, India, South East Asia and South and Central America, of which a number are worth well over £20m each.
To put the size of these projects into some perspective, in the financial year to end-March 2014, the company generated revenues of £6.1m, and guidance released in the trading update is for revenues of at least £8.5m in the current fiscal year to end-March 2015. In other words, if Software Radio lands only one of these contracts then it would be transformational for the business.
Importantly, the company has a live chance of doing so as the recognised brand leader in AIS, having had first-mover advantage with the launch of a miniaturised AIS core technology product in 2006. Moreover, Software Radio has an estimated 90 per cent share of the global AIS market through a range of 13 products, each of which is customised to suit the requirements of 150 value-added resellers servicing the end markets. Admittedly, it has taken years for the technology to really take off, but it appears the market for AIS is set to ramp up sharply in the coming years, and the best way of capitalising on this opportunity is through the market leader, Software Radio.
Pipeline of potential contracts
To give you some idea of the scale of the potential contracts, the recently announced mandate with the US Coast Guard, covering 10,000-18,000 vessels, is worth up to $10m (£6.4m) in revenues to Software Radio. The company also has a $6.75m (£4.3m) framework agreement for one territory in the Middle East and is in active discussions for another three worth a total of $50m-plus in revenues to provide AIS to over 100,000 boats.
In South America, trials of AIS are taking place in four countries, including Ecuador's fishing-fleet-monitoring programme, with a potential target market of 180,000 fishing vessels. This could be worth in excess of $50m in revenues to Software Radio. There is also potential for a similar sized contract in India, funded by the country's government, to put AIS identifiers on all of India's fleet of 200,000 fishing boats. But the biggest market is Asia, where Software Radio has five projects and mandated sales opportunities for a total of 250,000 vessels to generate revenues of around $75m.
In addition, the company is targeting a potential refit market worth $50m in revenues for over 100,000 vessels that were fitted with AIS equipment as part of the first SOLAS (Safety Of Life At Sea) mandate in 2002 as the original equipment installed comes to the end of its life or the ships' bridges are due for replacement. And, in the EU, around 10,000 boats have yet to comply with the directive to fit AIS, a potential market worth around $10m in revenues. In aggregate, these 21 potential sales opportunities could be worth around $300m in total to Software Radio.
Balancing risk and reward
Of course, there is no certainty that vehicle operators will immediately comply with legislation passed in the aforementioned territories. In fact, the economic downturn in southern Europe explains why there are 10,000 boats still to comply with the requirement to fit AIS transceivers. Also, some governments may not be as proactive in enforcing the requirement as quickly as the EU and US authorities have been to date. Still, there are 2m shipping boats where legislation has been passed or the process is under way that will require AIS transceivers in the next two to five years, according to analyst Eric Burns at broking house WH Ireland, which gives you some idea of the potential of the market.
It's also worth pointing out that Software Radio doesn't have this market all to itself. For instance, Taiwan's Alltek Marine offers custom AIS solutions primarily in the Middle East and Asia, rather than the EU and US. Norway's Jotron and Saab are direct competitors in Europe. And if the take-up of AIS proves as great as Software Radio's chief executive Simon Tucker predicts, then other competitors may decide to make the capital investment to update their core AIS technology, which would in turn whittle down Software Radio's technological advantage.
There is also the working capital issue as there is a substantial lead time for manufacturing - around six months according to Mr Burns. That said, the company had £5m tied up in stock at its September half-year-end, which should suffice for its immediate inventory requirements even if firmed up orders take off. The company also has a net cash pile of £1.6m so has funding available to cover higher working capital needs. I would also flag up the valid point that orders could be lumpy due to their nature.
In terms of the financials, Software Radio's losses are set to narrow from £1.5m last fiscal year to around £450,000 in the 12 months to March 2015, reflecting the surge in sales from £6.1m to £8.5m. For the March 2016 fiscal year, analysts conservatively forecast a small profit on revenues of £10m. Of course, those estimates could be blown out of the water if the company lands even ust one of the smaller contracts detailed above.
To illustrate how this could transform the bottom line, based on annual revenues of £12m, and maintained gross margins of 50 per cent, Software Radio could reasonably be expected to turn in cash profits of £2.8m and a pre-tax profit of around £800,000 after deducting the non-cash depreciation and amortisation charge of £2m. In other words, the company is now at an inflection point whereby incremental sales will have an accentuated impact on profitability as the operational gearing effect kicks in.
Technical indicators turning favourable again
Shares in the company took off from 25p to 34p at the end of last year following a presentation by the board to investors, and have been consolidating the gains ever since. That's a healthy process and has resulted in the share price trading sideways for the past couple of months, during which time both the 20-day exponential moving average (EMA) and the 50-day EMA have played catch-up and at 32p, and 30p, respectively, have risen to around the current share price.
In addition, the 14-day relative strength indicator (RSI) has unwound a heavily overbought reading of almost 80 at the start of this year and is now in neutral territory. For good measure, although the moving average convergence divergence indicator (MACD) is below its signal line, it's positive and the momentum oscillator appears to have based out. In other words, the technical set-up favours another attempt to take out January's high of 34p, beyond which a run up to the 40p-43p price band and a key resistance level that marked the top of the 2009-11 bull run is the most obvious next target.
True, this investment is more speculative as it is based on Software Radio converting its sales opportunities into firm contracts and then delivering on them. But given the scale of the AIS market, combined with a market-leading technology, the Aim-traded shares are worth buying ahead of next month's pre-close trading update - and one that has potential to deliver even more good news on new orders.
Needless to say, I rate the shares a speculative buy and have a target price of 40p-43p, valuing the equity at £50m-£54m - a valuation that would be justified if the company can double annualised revenues and maintain its gross margins within the next 12 months. Speculative buy.
MORE FROM SIMON THOMPSON...
Please note that since the start of February I have written articles on a total of 59 companies all of which are available on my IC homepage... and are detailed in chronological below with the relevant web links for ease of reference.
■ Flowtech Fluidpower: Buy at 130p, target 165p (‘A fluid performance’, 2 February 2015)
■ Inland: Buy at 57.5p, target 70p (‘A fluid performance’, 2 February 2015)
■ UK housebuilding sector: Run profits (‘A fluid performance’, 2 February 2015)
■ Globo: Conditional buy at 47p, target 60p (‘Going Global’, 3 February 2015)
■ Epwin: Buy at 92p, target 140p (‘Going Global’, 3 February 2015)
■ SeaEnergy: Buy at 21p, target 60p (‘Going Global’, 3 February 2015)
■ Fairpoint: Buy at 119p, target 190p (‘A valuable point to make’, 4 February 2015)
■ Greenko: Buy at 123.5p, target 225p to 230p (‘A valuable point to make’, 4 February 2015)
■ Safestyle: Buy at 165p (‘A valuable point to make’, 4 February 2015)
■ 600 Group: Buy at 15.5p, target 24p (‘Engineering growth’, 5 February 2015)
■ Global Energy Development: Speculative buy at 42p (‘Engineering growth’, 5 February 2015)
■ Pure Wafer: Hold at 42p (‘Engineering growth’, 5 February 2015)
■ Faroe Petroleum: Buy at 75.5p, target 94p (‘A slick operator’, 6 February 2015)
■ 2014 Bargain share portfolio updates:
Barratt Developments: Run profits at 458p; Taylor Wimpey: Run profits at 135p; 1pm: Buy at 67p; Bloomsbury Publishing: Hold at 148p; Camkids: Hold at 21p; Fortune Oil: Sit tight at 10p; Charlemagne Capital: Hold at 11p; Arden Partners: Hold at 47p; PV Crystalox Solar: Hold at 10.5p (‘How the 2014 Bargain share portfolio fared’, 6 February 2015).
■ 2015 Bargain share portfolio buy recommendations:
Mountview Estates, Crystal Amber, H&T, Pittards, Inspired Capital, Record, Netplay TV, Arbuthnot Banking, AB Dynamics and Stanley Gibbons (‘Bargain share portfolio 2015’, 6 February 2015).
■ Oil price (‘Profiting from the oil price slump’, 9 February 2015)
■ Getech: Buy at 45p, target 67p (‘Exploit a chart breakout’, 10 February 2015)
■ Moss Bros: Buy at 93p, target 120p-130p (‘A triple play of chart break outs’, 11 February 2015)
■ Manx Telecom: Buy at 189p, target 210p (‘A triple play of chart break outs’, 11 February 2015)
■ Oakley Capital: Buy at 155p, target 180p (‘A triple play of chart break outs’, 11 February 2015)
■ Walker Crips: Buy at 45p, target 54p (‘Delivering on a plan’, 12 February 2015)
■ Trakm8: Buy at 92p, target 120p (‘Zoming in on a profitable price move’, 16 February 2015)
■ Trifast: Buy at 111p, target 140p (‘Earnings upgrades to drive re-ratings’, 17 February 2015)
■ 600 Group: Buy at 16.5p, target 24p (‘Earnings upgrades to drive re-ratings’, 17 February 2015)
■ Pittards: Buy at 135p (‘Earnings upgrades to drive re-ratings’, 17 February 2015)
■ GLI Finance: Buy at 62.5p, target 80p (‘Income plays with capital upside’, 18 February 2015)
■ BP Marsh: Buy at 135p, target 170p (‘Income plays with capital upside’, 18 February 2015)
■ Henry Boot: Buy at 205.5p, target 249p (‘A bootiful investment’, 19 February 2015)
■ Jarvis Securities: Take profits at 435p (‘Decision time’, 23 February 2015)
■ Avation: Buy at 142p, target 200p (‘Decision time’, 23 February 2015)
■ Inland: Buy at 63p, conservative target 70p (‘Decision time’, 23 February 2015)
■ Globo: Buy at 49.25p, target 60p (‘Catalysts for re-ratings’, 24 February 2015)
■ Communisis: Buy at 56p, target 85p (‘Catalysts for re-ratings’, 24 February 2015)
■ SeaEnergy: Buy at 25p, target 60p (‘Catalysts for re-ratings’, 24 February 2015)
■ Netcall: Take profits at 71p (‘Taking profits’, 25 February 2015)
■ Eurovestech: Hold at 8p, target 10p (‘Taking profits’, 25 February 2015)
■ GLI Finance: Buy at 62.5p, target 80p (‘Taking profits’, 25 February 2015)
■ Amino Technologies: Run profits at 137p, target 150p ('Riding bumper profits', 26 February 2015)
■ Tristel: Buy at 80p, target 100p ('Riding bumper profits', 26 February 2015)
■ 32 Red: Buy at 60p, target 75p to 80p ('Riding bumper profits', 26 February 2015)
■ Non-Standard Finance: Buy at 103p ('A non-standard investment, 2 March 2015)
■ W.H. Ireland: Buy at 92p, target 140p ('A non-standard investment, 2 March 2015)
■ Simon Thompson's book Stock Picking for Profit can be purchased online at www.ypdbooks.com, or by telephoning YPDBooks on 01904 431 213 and is being sold through no other source. It is priced at £14.99, plus £2.75 postage and packaging. Simon has published an article outlining the content: 'Secrets to successful stockpicking'
