Ceragon Networks: Well-Positioned To Capture Emerging Markets Growth

We believe that given its position as a competitive player, with know-how and patented processes and technology, Ceragon (NASDAQ:CRNT) is well-positioned to take advantage of increased demand in the next years. We also believe that an acquisition is possible given the attempted takeover in 2022 by Aviat Networks for $3 per share. We think that many PE shops focused on networks and infrastructure might be attracted by a vertical integration play. In particular, this company and its assets (mostly the IP) can be easily deployed by bigger and well-established players that need some redundancy in their own infrastructure.

Ceragon provides wireless transport solutions, which are used to connect mobile network sites to the rest of the network, and/or as a backup service for fiber networks. It is also used where fiber solutions are not entirely possible, thus providing connectivity to unserved areas and clients. Ceragon seems to have positioned itself as a leader in the Wireless SDH to Wireless IP transitions, which is where the company has a competitive patented advantage. You can find more of this in the business overview in the 20-F here.

Growth will probably come from outside the US: The India case explained

We believe that the most favorable point for Ceragon is its position in developing countries. Indeed, as fiber is deployed more and more in developed countries, it is also interesting the global positioning of CRNT as a significant player in India, which is still building the majority of its infrastructure from scratch. This, along with the geographical characteristics of the country (which makes the deployment of fiber hard in many areas), could mean way more business for Ceragon than other countries.

Indeed, as noted in the latest 20-F, the company expanded its segmental revenue for India in the last 3 years, from 24% and 27%. While the US is still driving much of the growth (14% to 23%), we expect the marginal contributions and total market opportunity to be much more appealing for the India case. As European and American networks become more mature and less in need for redundancy and wireless services, this demand will likely be substituted by emerging needs in APAC and India.

The Indiatimes is reporting in this article that:

Not only in urban areas, but the people are also readily adopting the wireless internet in semi-urban and rural areas. As per a former report by Neilson, rural areas have 20% more internet users than urban areas.

This suggests that telecom adoption, and in particular wireless-based, will be the key to connecting rural and semi-urban areas that have a huge number of potential users. And again another article suggests that India will be the key to 5G adoption. There are many points that suggest that Ceragon is well-positioned to capture that excess growth, and we think that PE firms hunting for high-quality assets will notice this too.

Past results: mixed outcomes that need more stability

One of the reasons why CRNT is so cheap is probably also due to its past results and in particular cash generation. The company hasn’t done a great job and it had to borrow from short-term credit facilities in virtually every quarter.

This of course exposes the company to some risks such as rising rates and a possible liquidity crunch if the facility is maxed out or the lenders apply stricter covenants. However, there has been an improvement in the last quarter of 2023 in terms of cash from operations turning positive, and lower borrowing from the revolver. The overall change in cash has been positive despite higher capex, and this is motivating.

There is another source of concern that however is affecting the valuation. While cash generation improved, inventory days have skyrocketed to a multi-year high, close to 130 days versus sub-100 days for the 2021 period. This could create some issues like devaluation of inventory due to obsolescence, and eventually deeply negative write-offs of inventory. The market is probably trying to understand if this is a structural and chronic change or if it is a temporary headwind.

This may be one of the main reasons why the stock re-rated so much in terms of EV/Sales multiple. This came down from above 1.0x to 0.68x today, which is well below the average of 1.98x for the telecom wireless sector. The data can be found here.

Risks: what could go wrong for CRNT - the bear case

The risks for Ceragon assume very different shapes, from a straightforward execution risk to a more complex FX risk due to the high geographical diversification of revenues. We believe that investors should be aware that this is a competitive sector and the biggest threat comes from disruption by a competitor entering with better technology and/or better margins. This is probably also one of the reasons why the company has not been acquired already after being so cheap for so long.

While they definitely have an advantage demonstrated by ongoing relationships and a past track record, the patents pose very little protection in case of disruptive new technology.

Valuation: what is the right price for CRNT

Properly evaluating CRNT on a discounted cash flow basis would probably be reductive because it would not fully account for the importance of its positioning as a strategic player. The bulk of its value would be dispersed on long-run FCF that would be tremendously discounted, given the short-term Capex needs and volatility in results. So we decided to evaluate the company using the median and average multiples that have been used in past takeovers in the telecom sector. In particular, we will be using EV/Sales multiple, which compensates for the volatility in operating results. Also it is easier to account for the valuation premium deserved by being a strategic asset.

This table well summarizes the multiples on a P/S basis and EV/EBITDA basis. We immediately note that in terms of size, CRNT is positioned in probably the best range, $50MM - $500MM revenues. At this size, the EV/EBITDA multiple is maximized.

We will be using the 1.8x multiple which, even if below the market average (not median) of 1.98x, is reflective of also the risks that CRNT is exposed to. At this level the fair equity value (no need to subtract debt as P/S is measuring value on a pure equity basis), is $531 million, or around $6.20 per share. This would represent an upside case of more than 180%.

Conclusion

We believe that Ceragon is well positioned to take advantage of a prolonged period of structural and organic growth deriving from further development and expansion in markets like India. The company possesses the required know-how and experience to grow revenues and margins by bringing its technology to those markets that require connectivity more than anywhere else. Private Equity firms may be very interested in an asset like this and we think that a premium in the $6-6.20 per share range is well deserved.