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Examining the enlarged company

Writen by Ed Stacey

A LEADER IN SPECIALITY TECHNOLOGIES  

MTI Wireless Edge (LON:MWE) is a technology group focussed on communication and radio frequency solutions. The applications addressed include civil and military communications, wireless irrigation controls, and speciality consulting services in the antennas and electronics space.

MTI benefits from strong growth dynamics across its business segments. We are forecasting 21% EPS CAGR over the 3 years 2018-2020e. In this report, we examine some of the growth drivers. These include structural demand growth in wireless networks, water conservation demands in irrigation, and new contract wins in the defence/security and consulting businesses.

BROADENING THE BASE – THE MERGER WITH MTI COMPUTERS

MTI Wireless Edge is headquartered in Israel, and until recently was 53% owned by Tel Aviv-listed MTI Computers (MTCO.TA). In August 2018 the two companies merged under the London LON:MWE listing. Benefits of the merger include a broader revenue base, cost savings from a single market listing, and elimination of potential or perceived conflicts of interest.

Most importantly, in our view, the increased market capitalisation and the free float of MTI Wireless following the merger should bring the company "onto the radar screen" for more investors, which could lead to a re-rating in valuation terms.

FINANCIALS / VALUATION

MTI Wireless Edge has a net cash position of $4.6m (June 2018 accounts) providing a strong financial base. Furthermore, the company has been consistently profitable in recent years with gross margin 32-34% for 2015-2017 and operating margins 7.0-8.5%. Most importantly, in our view, the earnings growth trend remains intact. We are forecasting EPS growth of 19% for 2018e (pro forma basis, defined in this report) and 26% for 2019e.

In spite of the strong financial metrics and growth prospects, the shares currently trade on a 7.3x P/E multiple for 2019e. We argue that the valuation is incongruous with the company's financial strength and gross prospects. In this report, we examine the valuation in a peer-group context.

OVERVIEW

MTI Wireless Edge Ltd (LON:MWE) is a technology group headquartered in Israel and listed on the London AIM market. The company operates through four divisions.

Two divisions are the “old” MTI Wireless Edge businesses, which were part of the company before the recent merger:

Antennas - supplies antennas for both military and commercial markets from 100 KHz to 90 GHz.

Mottech Water Solutions – provides wireless remote control solutions for water management and irrigation applications, including agricultural, municipal and water distribution applications.

The other two divisions came into MTI Wireless Edge through the merger with MTI Computers, which was completed in August 2018. More details of the merger are on p4. The two divisions are:

Representation – provides expert consultation services specialising in RF and Microwave solutions and applications into the Israeli and  Russian markets. 

System Engineering - design and integration of aerostat operation systems, used for surveillance and border control.

The following charts show the revenue breakdown by operating division. These figures are calculated in a pro forma (pf) basis, meaning they are stated as though a full 12 months of the merged business were in place. We will use pro forma figures elsewhere in the report also.

We argue that MTI is well positioned to deliver growth in revenue and profits in the next two years. We examine the drivers in more detail in our divisional analysis (p5-p9). Some of the key drivers include:

• Ongoing structural growth for the Mottech irrigation business
• Mobile networks investment benefiting the Antennas division
• Representation benefiting from ongoing structural growth together with new client wins
• A major new contract in the System Engineering business affecting 2019e.

The following chart shows our forecasts for group revenues and gross profits.

We believe that the growth in revenue comes at broadly consistent gross margins (on a like-for-like basis pre/post-merger). We believe that selling, general & administrative (SG&A) and central cost growth will be constrained by comparison, leading to a strong drop-through of gross profit to net profit. We are forecasting earnings per share (EPS) growth of 19%, 26%, 19% respectively in 2018e (pro forma), 2019e and 2020e.

Valuation

In spite of the strong earnings growth potential, and a net cash balance sheet position, the shares have suffered a de-rating over the last six months in terms of valuation multiples. The following chart shows the P/E multiple of MTI Wireless Edge, on a 12m rolling EPS basis.

We can conjecture various possible reasons for this price/earnings (P/E) multiple compression:

• Pressure on the Emerging Market investment space in general in recent months, reflecting MTI’s geographic customer mix.
• Possible merger-related overhang, for example some holders of the former Tel Aviv listed MTCO.TA could now be exiting the London-listed      combined entity; however, we are not able to identify any specific selling trend along these lines.
• Pronounced share price weakness in one of the few listed pure-plays in irrigation systems – Jain Irrigation (BSE:500219); however, this company addresses different geographies and customers compared to MTI, and supplies a different category of products within the irrigation market.

Whatever the reason for the P/E compression for MTI Wireless Edge, we note that the valuation is now right at the bottom of its recent historic range.

BACKGROUND AND MERGER

MTI Wireless Edge was established in Israel in 1972, with a focus on antenna technologies for commercial and military applications, and listed on the London AIM market in 2006. Since listing, there have been two major corporate actions:

Acquisition of Mottech

MTI acquired Mottech Water Solutions, a provider of wireless electronic controls for irrigation systems. The logic of the deal was to expand MTI’s presence across the wireless systems value chain, and to access the high growth market of smart irrigation. Subsequent to the acquisition, Mottech has delivered 16.5% annual revenue growth (over two years 2016-18), and consistent strong profitability.

Merger with MTI Computers

In May 2018, MTI Wireless Edge announced plans for a merger with its own controlling shareholder MTI Computers (TASE:MTCO). The company cited the following benefits from the deal:

• Creation of a larger company with a broader revenue base
• Alignment of shareholder interests and elimination of potential conflicts of interest
• Cost savings and efficiency from having a single market listing on AIM
• Prospective increase in share liquidity due to enlarged free float

The following schematic shows the shareholding structure before and after the merger.

In addition to the simplified shareholding structure and potentially greater liquidity, the merger also gave rise to an enlarged and broadened revenue base. The following chart shows the impact of the merger in revenue terms, including the pro forma figures for 2017 and 2018e, and our forecasts for 2019e and 2020e. 

We argue that the enlarged group benefits from compelling growth drivers across all four segments. We next examine the business dynamics of each division.   

DIVISIONAL ANALYSIS

We consider some of the main drivers for each of the four divisions.

Antennas


MTI Wireless Edge develops and produces high quality, low-cost  antenna solutions for both military and commercial applications from 100 KHz to 90 GHz. Antenna solutions include smart antennas, multiple-input and multiple-output (MIMO) antennas and dual polarity for wireless applications such as LTE, WiFi, Broadband Wireless Access and Radio Frequency ID (RFID).

Applications include:

Commercial antennas

Commercial antenna solutions encompass directional, omni-directional and base station antennas, used in mobile networks infrastructure, Wi-Fi, public safety, and other applications.

Commercial – RFID

In RFID, MTI supplies radio frequency antennas for specialist application such as product ID in toll road, airport management and warehouses.

Military antennas

MTI Military products include a wide range of broadband, tactical and specialised communications antennas, antenna systems and direction finding arrays. Applications include airborne, ground and naval (including submarine) platforms for customers worldwide.

The following image is an example of an antenna application, in this case, a wireless access control system. 

We are forecasting solid growth in operating profit from the Antennas segment in 2018e, 2019e, 2020e, driven by steady revenue growth, some improvement in gross margins, and an operational gearing effect to operating margins. The following chart summarises the revenue and operating margin forecasts.

In 2015 and 2016, MTI reported revenue declines in the wireless broadband segment, driven in particular by one major customer scaling back demand in those years. The operating margin remained depressed in 2017 due to lower gross margin project work. We are forecasting growth in revenue and operating profit in 2018e.

Going forward, a significant driver is in back-haul point-to-point wireless network infrastructure, as network operators prepare for next generation applications. We also expect growth in the RFID and Military segments in the coming years.

Mottech

The Mottech Water Solutions business was acquired by MTI Wireless Edge in 2015. Mottech is the worldwide master distributor for Motorola’s IRRInet platform, which is an irrigation control system, i.e. the “brain” of a smart irrigation system. Based on the IRRInet platform, Mottech provides comprehensive water management systems for agricultural, municipal, and water distribution applications.

Smart irrigation is a growth industry worldwide, driven by water conservation concerns. The chart below shows the growth in the smart irrigation market, including the controllers segment, which is applicable to MTI Wireless. We expect this segment to grow in line with the industry’s products growth rate of 17% p.a.


 

We are forecasting growth in revenue and operating profit for the Mottech division in 2018-2020e. The following chart summarises our revenue and operating margin forecasts.

Operating margins declined in 2017 due to increased marketing expense, particularly in relation to expanding the business’s presence in Asia. Going forward, we expect steady gross margins, with operating margins beginning to increase due to operating leverage.

Representation

The Representation division provides consulting services to international electronics businesses with respect to their operations in Israel. The business promotes a select group of international suppliers of RF/Microwave, satellite communication (SATCOM), and optic fibre components and systems, providing customers a complete solutions package. More recently the Representation business has expanded into Eastern Europe.

The Representation business has grown at an annual rate of 15.6% over the three years 2015-2018e. We are forecasting a continuation of robust growth in 2019e and 2020e based on additional client wins. Although Representation is smaller than Antennas or Mottech in revenue terms, this division is a material incremental profit driver for the group due to the strong drop-through of additional Representation revenue to the operating profit line. The following chart summarises our forecasts.

System Engineering

System Engineering is the smallest of the four divisions in revenue terms; however, this business is potentially a significant incremental driver of group profits in 2019e, and therefore significant to the investment thesis. 

The System Engineering business provides lighter-than-air systems, known as aerostats. Effectively these are tethered airships that carry surveillance equipment for defence, border security and other applications. The image below shows some MTI lighter-than-air systems.

In these projects, MTI acts as a systems integrator. The airship itself is supplied by a specialist supplier (the example above is from TCOM of the USA), while the monitoring equipment comes from defence companies such as Rafael Advance Defence Systems of Israel. MTI project manages the configuration of the system and its entry into service. MTI also has the ability to deliver a managed service offering, overseeing the operation of the aerostat system after it has entered service.

This division has significant operating profit upside in 2019e in our view. The following chart summarises our revenue and operating margin forecasts.

We are forecasting a reduction in revenue and operating margin in 2018e versus 2017, based on programmes completing in 2017. In 2019e we are forecasting a strong uplift in revenues for System Engineering based on significant new projects. This is outlined in the document “Valuation Report of MTI and MTIC” within the merger documents of the MTI Wireless Edge investor relations site. The increased contribution from System Engineering is a material contributor to our group-wide earnings growth forecast for 2019e.

FINANCIALS

MTI delivered strong growth in operating profit and in earnings per share in 2017 (either pro forma or as reported), and we expect this to continue in 2018e based on the commentary around the first half results released August 28. For 2019e and 2020e ,we are forecasting EPS growth of 26% and 19% respectively.

Looking specifically at the earnings growth drivers in 2018 and 2019:

For 2018e we are forecasting a recovery in operating profit for Antennas, with continued growth for Representation, offset by reduced operating profit from System Engineering due to projects completed in 2017.

For 2019e we seen Antennas, Mottech and Representation benefiting from structural demand growth, with operational gearing driving additional profit growth for Representation. We see a strong uplift in profit for System Engineering driven by the new Israeli programme.

The following chart summarises our operating profit growth expectations for 2018e (pro forma) and 2019e.

We expect balanced growth across the divisions continuing into 2020e.

This growth in operating profit drives strong growth in earnings per share. Overall, we are forecasting EPS growth of 19%, 26%, and 19% in 2018e (pf) 2019e and 2020e respectively. The following chart summarises our EPS growth forecasts.

One of the key elements of the MTI Wireless Edge investment thesis, in our view, is a mismatch between the strong EPS growth prospects, and the P/E valuation ratio of only 7.3x. We examine this further on p11.

Cash position

We conclude our financial overview with a summary of the company’s cash position. The following chart shows the cash-flow bridge for 2017-2018-2019e. We are using pro forma balance sheet figures for 2017 and pro forma cash-flow for 2018e. We note that MTI Wireless Edge had a cash positive balance sheet position also on a pre-merger basis.

We argue that the net cash position provides a strong financial base for the expanded group. If the net cash position continues to grow, we believe that the company could consider an accelerated dividend payout or exploring M&A options in future.

VALUATION

In order to assess the P/E multiple being applied to MTI Wireless Edge, we would like to make a comparison with similar companies; however, given the unusual mix of business areas that MTI operates across, there are really no comparable companies, as such. Instead we have selected a group of stocks covering various different geographies and end markets, and different market cap brackets. The following table summarises our “comps” universe.

We compare valuation multiples based on consensus 2018e P/E multiples where available. For Smartlink holdings, we show a 2017 P/E multiple.  

In fact, we argue it would not matter much what universe of stocks we use as peers – electronics, communications equipment, defence, UK or global, small-cap or larger.  Against any reasonable comparators that we can identify, the MTI valuation of 7.3x P/E is unusually low.

Conclusion: 

We argue that MTI Wireless Edge offers substantial earnings growth in the 2018-2020 time-frame, driven by a strong portfolio of technologies. We believe that the current valuation represents an interesting entry point.

FORECASTS

P&L

CASH FLOW 

Balance Sheet 

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