The company's customer base includes major manufacturers of mobile devices, chipsets and network equipment, mobile network operators, regulatory authorities, and independent test houses. Semiconductor companies developing wireless semiconductors generate 25 per cent of Anite's revenue including Qualcomm (QCOM:NSQ), Intel (INTC:NSQ), and Samsung (SMSD); mobile phone original equipment manufacturers (OEMs) such Apple (AAPL:NYQ) account for 30 per cent; wireless mobile operators around 20 per cent; and the balance of turnover is made up of network equipment vendors such as Ericsson (ERIC:B:STO) and Nokia (NOKIA:BUD). Samsung is the company's largest customer, but there is a decent spread of business as no customer accounts for more than 10 per cent of Anite's revenue, albeit that could change in time as the company is seeing growth in China as the country's OEMs increase their level of testing by targeting the export market.
It's the type of business other investors have been paying close attention to as the shares have been making steady headway towards a major resistance level, a price point that has capped progress on a closing basis at 95p for the best part of the last two years. But there are strong reasons to believe that a share price break-out could be on the cards, and one likely to be sparked by the company's financial results for the year ended 30 April 2015, to be announced on Wednesday, 1 July.
Bumper results expected
Firstly, a pre-close trading update a fortnight ago confirmed that profits for the fiscal year just ended will meet analyst's high growth expectations. This is worth noting because around three quarters of Anite's profits are earned in the second half, reflecting a seasonal bias in demand for handset testing from mobile manufacturers and networks. For instance, technology analyst Eoin Lambe at brokerage Liberum Capital predicts that Anite's revenues will rise by 9 per cent to £119m in the 12 month trading period, implying 13 per cent growth in the second half, to drive up adjusted pre-tax profits by almost half from £14.9m to £22.1m. On this basis, expect underlying EPS of 5.64p, up around 46 per cent on fiscal 2014.
Moreover, with Anite's net cash rising by over 20 per cent since the end of October to £36.9m, a sum equivalent to 12.4p a share, then expect shareholders to be rewarded with a 10 per cent hike in the dividend per share to a shade over 2p. On this basis, the shares are priced on a cash adjusted PE ratio of 14 and offer a prospective dividend yield of 2.2 per cent.
That historic rating is quite some discount to Anite's peer group which includes FTSE 250 constituent Spirent (SPT), rated on 19 times fiscal 2015 earnings estimates, or Nasdaq-listed NetScout Systems, Inc. (NTCT:NSQ), on a forward PE ratio of 22.
In fact, the valuation anomaly becomes even more pronounced in the current fiscal year when the company is forecast to grow revenues by a further £10m to £129m to boost pre-tax profits by 15 per cent to £25.5m. On this basis, expect EPS of 6.5p. This means that the cash adjusted PE ratio falls to just above 12, a massive discount to peers, and 2.5 points below the average rating the shares have traded on over the past five years. Furthermore, the prospective dividend yield increases to 2.5 per cent based on a raised payout of 2.28p a share.
On sound technical foundations for growth
Importantly, Anite's board points to "encouraging activity levels and growing sales pipelines" since the April financial year-end. Indeed, revenue growth for the company's devices and infrastructure business, accounting for 70 per cent of total operating profits, is being driven by continual technological advancements - 4G phones require 25 per cent more testing than 3G handsets, for instance; market share gains; and expansion of its addressable market.
Earlier this month, Anite signed a deal with China Telecom to use the company's SAS system for LTE data throughput testing. A number of other major mobile operators in China, US and Europe use Anite's interoperability and performance test solution for rapid verification of new devices too. That's because when a mobile operator and device manufacturer use SAS together to run approved mobile operator test plans, it enables devices to be tested more accurately and rigorously through straightforward replication of a wide range of test scenarios specified by the mobile operator. In turn, this reduces the risk of device rejection and accelerates the time it takes to bring the new products to market.
The target market for Anite's devices and infrastructure business is worth around £545m, and growing. It's not alone as Spirent and Netscout estimate their markets will grow this year by 8 per cent and 10 per cent, respectively, largely reflecting technological advances and the need for greater testing. As a result analysts predict Anite's division should be able to capture a 15 per cent slice of its market this year, implying an 8 per cent increase in divisional revenues from £84.7m to £91.5m.
Operating margins are very respectable at 20 per cent, reflecting a stable recurring revenue stream (worth between 15 to 20 per cent of turnover) from maintenance contracts and high barriers to entry - new mobile phones have to be tested against older standards making it hard for new entrants to break into this niche area as current operators have already incurred many years of research and development spend which would be expensive to replicate. The bottom line is that if Anite delivers single-digit revenue growth in its devices and infrastructure business then operating profits here can be expected to ramp up at twice the rate of revenues from £17m to around £19.2m in the year to April 2016.
Expect growth in Anite's network testing business too which has grown by 12 per cent a year on average in the past five years through servicing the needs of 400 customers in 130 countries in a market worth £445m. Though the smaller of Anite's two divisions, the business is more stable and boasts a 20 per cent operating margin. Analysts expect revenue growth of 10 per cent to £37.8m in the current fiscal year to lift operating profit by around 15 per cent to £8m. This business primarily sells products that enable mobile operators to test and optimise their networks (Liberum estimate this areas accounts for around 80 per cent of divisional revenue), with the balance being made up of sales to network equipment vendors. Anite's products use mobile phones and scanning receivers with dedicated software to collect and subsequently analyse the data from a live network to ensure it is working as expected.
The bottom line is that with margins stable, profits rising on the back of both increased testing requirements and underlying industry growth, then there is a realistic possibility of Anite delivering the double-digit profit growth analysts predict in the current financial year. That makes a cash-adjusted forward PE ratio of 12 far too low, and a valuation that could attract predatory interest.
Potential takeover target
It's worth noting that most test and measurement companies tend to have the same customer base, but limited product overlap. As a result, there is potential for material cost savings in the area of sales and administration if companies merge their businesses. For instance, Anite's distribution and administration costs accounts for just over a quarter of its annual revenues, so the savings here could be material if the company was taken over by a larger rival. That seems more likely now that recent corporate activity has led to the formation of pure play test and measurement businesses.
For instance, Agilent Technologies (A:NYQ) spun out its testing business to form Nasdaq-listed Keysight Technologies (KEYS:NYQ); Netscout bought Danaher's testing business; and Anite sold its travel business focusing solely on test and measurement. Mr Lambe at Liberum believes Keysight and Rodie & Schwarz, a German manufacturer of test and measurement equipment for mobile radios and radio communications, could be potential consolidators given their relative size. Keysight does not have a strong position in 4G and may look to boost its position in 5G.
Interestingly, Keysight's chief executive Ron Nersesian made the following comment during his recent conference call to analysts: "Because of the limited number of prospects that exist and the competitive environment, we're not commenting on what we plan to do in M&A. I will tell you though that our focus, which is all around improving our wireless communications portfolio, improving our modular offering and improving our software capability and extracting above-market growth rates from those three areas, would be the areas that are very important to us."
Bearing this in mind, Anite has a strong focus in wireless testing, and both its chief executive Christopher Humphrey and finance director Richard Amos have been involved with businesses that were sold in the past. In my opinion, this increases the chances of Anite's board being amenable to predatory interests given the deep valuation disparity with peers.
Risk assessment
Clearly, there are risks to consider, the most obvious being a potential slowdown in spending once 4G roll-out peaks in 2016 and before 5G takes-off in 2020. Indeed, it was the slowdown in spending on older 2G/3G testing technology before 4G really took off that led to Anite issuing a profit warning in October 2013. It also explains why profits in the financial year just ended have surged so much given the weak comparables in fiscal 2014.
Secondly, test and measurement businesses have high operational gearing which when combined with limited visibility on sales (around 8 weeks lead time), makes for more volatile earnings. That's not an issue right now because Anite's pre-close trading statement mitigates risk, but it's a factor worth considering nonetheless.
Thirdly, Anite has made four small bolt-on acquisitions over the past couple of years, so on the basis the board aim to run a neutral cash position over the long-term, this points to more deals being done. The company could easily spend around £65m on an acquisition, including its £36.9m net cash pile, if it taps undrawn credit lines of £30m. Net asset value is £137m, so the company would still be comfortably geared, but acquisitions do increase investment risk as there is no guarantee they will deliver. That said, I still feel it more likely that Anite will be acquired for the reasons I have outlined above. In any case, it can only do small bolt-on deals as it is too small to be a consolidator.
Target price
The bottom line is that with Anite's shares priced on 12 times cash adjusted earnings for the 2016 fiscal year, and supported by a prospective dividend yield of 2.5 per cent, I feel that the rating is out of sync with a business predicted to generate double digit earnings growth this year. The discount to peers is simply too large, a point that will become far more apparent when Anite releases its bumper set of fiscal 2015 results.
In the circumstances, I recommend buying Anite's shares now on a bid-offer spread of 91p to 91.5p, and have a year-end target price of 110p. This target coincides with the share price highs at the start of last year and would value the company's equity on 15 times cash adjusted earnings estimates. Buy.
Please note that my next column will appear on our website at 12pm on Monday, 1 June 2015.
MORE FROM SIMON THOMPSON...
At the end of April, I published an article with all the share recommendations I have made this year and have published articles on the following 25 companies in May:
■ Marwyn Value Investors: Buy at 220p, target price 260p ('Exploiting a value play', 5 May 2015)
■ Pure Wafer: Buy at 113p, target 140p to 150p; Paragon: Run profits at 440p, but buy on a confirmed breakout above the 445p and new target of 500p; 600 Group: Buy at 16.5p, target 24p; Fairpoint: Buy at 127p, target 190p; AB Dynamics: Buy at 207p, target 230p ('Repeat buy signals', 11 May 2015)
■ Globo: Buy at 56p, target 69.5p; Greenko: Hold at 70p; Pittards: Buy at 128p ('Break-out looms for mobile wonder', 12 May 2015)
■ Macau Property Opportunities: Buy at 214p; Dragon-Ukranian Properties & Development: Hold at 28p; Raven Russia: Hold at 53p ('Overseas property plays', 13 May 2015)
■ Trakm8: Run profits at 135p; Redde: Buy at 120.75p, target 140p; STM: Run profits at 45p, but conditional buy on close of 48p and new target of 60p ('Smashing target prices', 14 May 2015)
■ Bilby: Buy at 75p, target 100p ('Buy to build' growth play, 18 May 2015)
■ Bioquell: Buy at 148p, target 170p to 185p; Somero Enterprises: Buy at 140p, target 185p; KBC Advanced Technologies: Buy at 109.5p, target 165p; Inspired Capital: Hold at 14.25p ('Three value plays', 19 May 2015)
■ Renew Holdings: Buy at 315p, target range 350p to 375p; Manx Telecom: Buy at 198p, target 210p ('Renewing old acquaintances', 20 May 2015)
■ Marwyn Value Investors: Buy at 228p, target 260p; Charlemagne Capital: Hold at 13.5p; Bloomsbury Publishing: Hold at 178p ('Lights, camera, action', 21 May 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 £2.95 postage and packaging. Simon has published an article outlining the content: 'Secrets to successful stockpicking'
