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Here's A Cutting Edge Networking Company In A Deep Value Screen

When reviewing a deep value screen like Magic Formula® Investing (MFI), it always piques the interest to discover a company that has 5-year compound annual revenue growth of 34% and operating income growth of 112%!

Nevertheless, these kinds of stocks DO appear, and when they do they can frequently deliver HUGE gains, as investors benefit from the "double play" of a return to a more reasonable valuation combined with continued earnings growth can easily deliver enormous gains in a relatively short amount of time.

Value investors might recognize this setup as the Shelby Davis "Double Play". Davis used this "growth-at-a-bargain-price" strategy to turn $50,000 into over $400 million over a 45 year period.

So, now you can see why Ubiquiti Networks (UBNT) spiked my interest when it recently showed up in MFI!

Of course, the key question is not what past growth is, but can future growth approximate it? Let's examine the company, why the stock sells reasonably cheap at present, and what the future prospects are.

Equipment For Next-Generation Wireless Networks

Ubiquiti sells wireless networking equipment. It classifies its products into two groups: Service Provider Technology and Enterprise Technology, based on the targeted end customer.

Service Provider Technology is targeted at (you guessed it), service providers (think AT&T (T)) and generates about 71% of sales. It consists of the airMAX, airFiber, and EdgeMAX lines:

  • airMAX: Wireless base stations, backhaul, and bridge equipment.
  • airFiber: Point-to-point wireless backhaul equipment.
  • EdgeMAX: Ubiquiti's network routing platform. Routers, switches, security gateways.

Enterprise Technology (29% of sales), targeted at business usage, consists of the UniFi, UniFi Video, UniFi VoIP and mFi product lines. The UniFi lines are integrated wifi, video surveillance, and voice systems. mFi is a line of network-enabled devices with hardware sensors, allowing remote control of things like building temperature and power consumption.

Ubiquiti is a true global company. About 35% of the company's sales are in North America, 34% in EMEA (Europe, Middle East, Africa), 21% in South America, and 10% in Asia.

4 Things To Like About Ubiquiti

Ubiquiti passes a lot of the simple tests of a good stock.

First, the company has generated outstanding growth. Even in the most recent, "disappointing", quarter, Ubiquiti generated 16% revenue growth, with both of its segments delivering double-digit percentage growth. Guidance for Q2 was somewhat weak, with only 8% revenue growth forecast at the median. However, for the full fiscal (June) 2015, Ubiquiti should deliver solid 10% revenue growth. Longer term, wireless networking has a nearly unlimited application horizon. IP traffic will continue to grow at 20% a year. Wireless backhaul, video surveillance, and network-enabled devices are tremendous growth markets currently in the early-to-middle stages of build-out. Growth potential is a strong positive.

Secondly, the company has impressively been able to maintain very high, mid-30% operating margins. Ubiquiti has a unique, social-network oriented strategy called the "Ubiquiti Community". Basically, the firm's customers act as both a marketing and tech support channel, both through company-sponsored and third party channels. This allows Ubiquiti to spend under 4% of revenues on SG&A - very impressive. For comparison, Cisco (CSCO) spends about 24% of revenues on SG&A! This margin has shown no signs of being in imminent danger, either.

Third, Ubiquiti has great financial metrics. $391 million in cash on the balance sheet dwarfs the firm's $72 million in total debt. Free cash flow conversion is strong, about 100% of net income over the past 5 years. The firm instituted a small (0.53%) dividend last quarter.

Finally, I really like the management team. Robert Pera, a former Apple (AAPL) network engineer, founded Ubiquiti in 2003, grew it, took it public, and still sits as CEO today, maintaining 65% ownership of the company's shares. Even more impressive, Pera is just 36 years old! I love founder-run companies - they are typically run for the long term and we can be confident our interests are aligned with management's.

Those are four very strong arguments for UBNT as an investment candidate.

Why The Stock Is "Cheap"

So how does such a seemingly attractive stock find its way into the Magic Formula screen?

Really, we've covered it already: UBNT's Q1 results were below expectations and Q2 guidance was as well. Management has noted noted geopolitical weakness in both its EMEA and Asian markets. Given the worsening problems in Russia's economy, and generally weak IT sales in China, this seems reasonable. Things seem to be getting worse, too, and Q2 could be another "miss" for UBNT.

When To Buy

In the big picture, the primary risks here look short-term, and are not company-specific. A week or so ago, UBNT was selling near $27, and at that point it would have been a slam dunk Top Buy candidate.

But, alas, the stock rose 7% yesterday and is no longer the strong bargain it was when I began this article. Assuming about 6% earnings growth this year, followed by a drab 2016, but a strong rebound after that, UBNT looks worth about $36/share. At the current $32 quote, that's about 13% upside - not bad, but not great. We would really like to see the stock get back down under $27 or $28 before becoming interested. For those comfortable with options, the January puts in that range might be attractive to sell at current prices.

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