Radisys Restructuring Overshadows Company’s Value Proposition

May 1, 2015 • Trading Idea • Tags:

Radisys’ (RSYS) restructuring from its legacy hardware business is progressing as planned. To quickly recap, Radisys is undertaking a strategic shift to become a software centric business that will take advantage of 4G/LTE services such as VoLTE, a network that treats voice services as data rather than depending on voice specific networks. In economic terms, VoLTE has more capacity than conventional networks, better call quality and lower costs for carriers. A more detailed explanation of Radisys’ restructuring can be found here.

Software Growing and Expenses Declining

The company announced indicative Q1 2015 results. Overall revenues grew 11% to $48.7M, with software revenues up over 20%. Margins were up slightly due to the savings in the company’s hardware division. Operating expenses were down to $13.6M, a decline of $3.4M YoY and $1.9M QoQ. Management expects operating expenditures to continue this trend in the second half, when the figure will normalize to about $12.5M/quarter.

Radisys reported a non-GAAP EPS of $.03 for the quarter, signifying the financial benefits of the company’s transition to software. Growth (20%+), higher margins (55%+), lower operating expenses and profitability are going to become a regularity if Radisys executes the transition. The company projects Q2 2015 to follow the trajectory.

Q2 2015 Projections

At the above assumptions, software revenues would grow by 30% YoY. This is in line with management’s expectations for the full year software growth rate to be around 20%. Additionally, Radisys plans to use the flat, but profitable hardware business to fund the growing software arm. For the year, management expects software to lose between $8M and $2 M, but to become profitable in 2016. In the Q1 earnings call, CFO Jon Wilson guided that software breakeven would be around $14M.

Radisys has a cash balance of $15.8M, a figure expected to increase by approximately $2M for Q2 results. The transition to software will speed up the company’s ability to generate cash due to quicker collections.

Where Will The Software Growth Come From?

Radisys provided updates on each of the three software services the company offers.

  1. MediaEngine

MediaEngine is a media processing platform for multiple communication services. For example, being able to play and process a mix of audio and video media streams simultaneously. As 4G/LTE expansion spreads worldwide, mobile video and data demand rises. Radisys is in over 30 trials with carriers who are supporting 4G/LTE growth and services such as VoLTE, VoWIFI and WebRTC. These trials vary across Europe, N.America and Asia.

The trials are essentially tests that will determine whether the carriers become Radisys customers. One of these carrier trials could be India’s Reliance Jio, which will introduce voice-plus-data mobile services in five cities by June. This could also be the large Asian carrier that Radisys referenced in their call. The company expects a “handful” of these trials to convert into production throughout remainder of 2015.

  1. FlowEngine

FlowEngine targets the traffic management market that’s being driven by expansion of video streaming, mobile devices and the Internet of Things (IoT). These solutions will be sold to telecom equipment and data-center manufacturers, as well as directly to carriers who are keen on understanding and monetizing the data flows.

In the fourth quarter, Radisys shipped initial trial units to a “significant North American carrier” and received acceptance of these in the first quarter. The company also received a second order from this same carrier last week for additional trial units. Though these units won’t contribute meaningful near term revenue, it can be safe to speculate that this North American carrier is close to becoming a customer. Radisys could generate meaningful revenues from such a client during 2H 2015.

  1. CellEngine

CellEngine is software that is deployed in small cells, which are short range base-stations that complement mobile service from larger macrocell towers. Think of small cells as small routers that would increase service quality in hard to reach places such as buildings and underground. CellEngine is the software inside these routers.

Radisys sees CellEngine as more of a 2016 story as global carriers are still adopting the use of small cells. When deployment begins in volume, Radisys will be well positioned to realize revenues and royalties from hardware partners like Intel and Qualcomm.

Radisys Value Proposition

At a current market cap of $85M, Radisys is trading at less than 6x the estimated 2015 profits of the hardware business alone. Management projects operating income of $13M-$17M from the hardware segment. At these valuations, investors are essentially getting the fast growing software business for free. Even if software is valued at only 1X 2015 revenue (~$45M), Radisys would be trading 50% higher.

Markets are overlooking Radisys’ transition to software, thereby valuing the company by its declining hardware business. However, as explained above, software is growing at 20% and Radisys’ pipeline should give investors confidence that the growth should continue into the remainder of 2015.

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