Description

Investing in an industry leader with lots of cash on its balance sheet is always attractive. Aether Systems is a dominant player in the world of developing and implementing wireless solutions. The company’s focus is enabling enterprises to make their various applications (email, programs, databases, etc.) available on any type of mobile/wireless device, regardless of network type. The company currently has over 3,000 clients and is involved with 21% of the Fortune 100. In addition, it is in with discussions with an additional 64% of those companies. Customers include Goldman Sachs, Charles Schwab, US Postal Service, Coca-Cola, Becton Dickinson, MCI/Worldcom, Sony, Sun Microsystems, and TD Waterhouse.

Thanks to a timely secondary offering and convertible debentures offering in early 2000, the company is currently sitting on a cash balance of $725MM, while its enterprise value is $960MM (Market cap of $625MM and debt of $335MM (face/book).

Unfortunately, the company is still burning through cash. At the end of 2000, its cash balance stood at $875MM, so the company used $150MM during the first quarter of 2001 ($58MM EBITDA loss, $56MM one-time investment, $36MM working capital/other). Fortunately, management realizes that they must reduce this cash outflow and has decided to stop making external investments (reversing a decision made in January to ramp up investments given the opportunities made available by the tech turmoil).

While cash is being burnt, the company is delivering on the revenue front – from revenue of $26MM in Q4:00, it has said revenue will be $30MM in the first quarter. It is also comfortable with projections of at least 15%-20% quarterly sequential growth for the remainder of 2001 (a slight reduction from guidance at the beginning of the year, but fairly impressive nonetheless). Of course, revenue growth doesn’t mean diddly without improving profitability. Company management believes it’s on track to achieve EBITDA breakeven by Q3:2002 – the same time frame predicted in January (and a quarter early than prior expectations.) At that time, the company should still have about $450MM or so at that point.

At a recent analyst meeting, Aether announced a new product platform called Aether Fusion that integrates most of its existing software offerings (the company has used acquisitions to expand product reach). This offering, combined with the company’s current strategy, should lead to a 2003 revenue stream that is 63% software, 25% subscriber services, and 12% engineering (Q4:00 was 51% subscriber services, 34% software, and 15% engineering). This should result in a business that over time is much more profitable and leveragable.

Company founder David Oros, who had been president of Westinghouse Electric’s Wireless Data Group, is still at the helm as CEO. President George Davis, the former Director of Enterprise Management Systems at Northrop Grumman’s Information Management Systems Division, has been with Aether since 1996, the year Aether was founded. Insider holdings are substantial, standing around 39% in March 2000 (this has probably declined with recent lockup expirations, but holdings are still substantial.

The wireless data arena should be enormous over the next few years and Aether is a leading player in making sure everything works for an enterprise customer. With its people, technology and significant cash horde, this role should be maintained and enhanced.

Now, why select the convertible bond over the stock? It’s certainly not for the conversion feature, which is at $243.95 a share (Aether stock is currently $13.89). Basically, I view these converts as a way to achieve equity-like total returns with the reduced risk associated with being a bondholder rather than stockholder. At the current quote of 59 (you should be able to get them a little cheaper, but I want to be conservative), investors get current income of 10.2% (interest payments are in March and September). Assuming the company makes it to maturity in March 2005, you’ll also get appreciation in the bond to 100, providing potential total return in excess of 20%. While not the unlimited potential offered by the equity, I find this return quite satisfactory and believe the risk is significantly lower than that embedded in the stock.

Catalyst

The catalyst for these bonds will be waiting for the wireless marketplace to mature and seeing that Aether remains a leader and develops a profitable business model. Everything related to the wireless technology sector has been pummeled. The market is currently uncertain and everyone wants to shy away from it. I don’t blame them. Even I’m shying away from Aether’s stock given the sector turmoil.

Nonetheless, Aether should be an industry survivor with a leading technological position, excellent client base, and $725MM cash in hand. Assumed cash on hand of $450 million at the point of projected breakeven in Q3:02, would cover all of the company’s outstanding convertible subordinated debentures and still leave $120MM for further investment. While this investment is not risk-free, this investment will payoff 20% if Aether can survivor until 2005 (or acquired by someone who wants to be a big player in the space). I think those odds are pretty good.

While this investment can’t be a home run since its total return is capped at just above 20%, it seems like a pretty nice double or triple to me.