Description

SUMMARY THESIS

Daktronics Inc (Nasdaq: DAKT or “the Company”) presents a very attractive long opportunity after having undertaken multiple operational upgrades over the last couple of years combined with a recapitalization earlier this year that have significantly improved its financial profile. The Company is the domestic industry standard in live events large screens (>70% market share) and the market leader in scoreboards, digital billboards and other programable displays solutions (45% share). It is the only current domestic manufacturer of LED displays across the categories in which it operates. Demand for nearly all its core products is benefiting from upgrade cycles at all levels, expanded adoption and secular tailwinds which are supportive of ongoing growth for the next several years. We estimate DAKT has +100% upside over the coming quarters with a number of catalysts supporting this outcome.

SUMMARY BACKGROUND

We initially balked at investing given the YTD run-up in its stock price. Upon further review, we concluded that the risk/ reward associated with the set-up now is arguably as attractive as ever. It is important to note that DAKT traded at a nearly all-time low earlier this year when it was on the verge of insolvency as a going concern, having been hampered by cost overruns, one-time capital investments, bloated inventory and component supply chain issues which delayed product deliveries. The matters have since been resolved and it is now operating with a rationalized cost structure and higher margin profile. Additions to its board of directors by activists have also bolstered its corporate governance, improved shareholder alignment and to a certain degree, helped professionalize the organization. This opportunity exists because of these dynamics, limited institutional awareness of the Company, zero sell-side coverage and limited management guidance.

SUMMARY VALUATION

Assuming some moderation in growth as it laps the completion of two large projects and improved cost structure, we estimate DAKT will generate $1.25-1.45 of EPS in FY2024. This implies 7-8x EPS/ 4.5x EBITDA at the current share price. This baseline will reflect the lapping of the one-time challenges in FY2023 and serve as a logical representation of its normalized earnings power. In a base case scenario thereafter, revenue growth should track to 10% annually with earnings and FCF rising at a higher rate. Our estimate of intrinsic value is $18-22 per share (70-100% upside) under different scenarios.   

SUMMARY GROWTH DRIVERS

1. Moderation in the cost of LED components and improved functionality have expanded its application and market opportunity.
2. Upgrade cycle from legacy LCD and older LED displays (SDR and 4-K) to next generation in HDR LED (higher resolution, more colors, better image clarity, content legibility, brightness, versatility and durability) is still in its earlier stages with arena upgrades now much broader in size and scope.
3. The need to enhance the experience of attendees at live events through visual displays and audiovisuals in an increasingly screen-oriented culture. The phenomenon surrounding the MSG Las Vegas Sphere seems to have created an incremental interest in the application of larger LED screens and raised the bar for the scale of adoption as a part of live entertainment.
4. The increasing ubiquity and appreciation for the value of dynamic displays (particularly versus static signage) should be a driver of ongoing demand for the foreseeable future.
5. The financial strength of end-customers is supportive of ongoing growth for the category.

SUMMARY CATALYSTS

1. A higher appraisal of its share value as Daktronics demonstrates the sustainability of its recent financial performance supported by the: 1) new product launches and strong backlog; 2) recent operational and cost structure improvements; 3) lapping of CRM upgrade costs; and 4) a step-down in capex as automation investments are completed over the next couple of quarters. This will yield a higher FCF and earnings profile.
2. The next reported quarter is an easy comp which will also improve how DAKT screens statistically on an LTM basis.
3. Sell-side initiations and increased corporate outreach to expand investor awareness of this opportunity.
4. Potential sale given its strategic value and appeal to private investors.

FINANCIAL SUMMARY BY SEGMENT

Daktronics provides fairly granular segment level and operating data. Note: April fiscal calendar year-end. The Company’s LTM revenue breakdown: Live Events – 39%, Commercial – 22%, High School & Recreation (HSPR) – 20%, International – 10% and Transportation – 9%.

BUSINESS SEGMENTS (OVERVIEW & DRIVERS)

OVERVIEW

Daktronics is a vertically integrated manufacturer of almost all its products with production facilities in the US (1), Ireland (1) and China (1). The Company currently has the capacity to significantly increase output following facility expansions over the last three years. Approximately 50% of its projects are built-to-order, customized unique configurations and the rest are standardized systems with limited configuration. The Company also derives 7% of its revenue from software licenses for its operating system, support services and parts. Larger projects and orders are managed through direct sales with limited configuration typically sold by regional sales teams and through the distributor channel. Across its segments, Daktronics is the largest North American provider of LED video displays with a 45-50% market share. It has established this position through longstanding relationships with integrators and its reputation for quality and serviceability. The North American LED display market is expected to grow at a +20% CAGR (90% of DAKT revenue) and at a more rapid pace globally through 2028 per Futuresource and other estimates.

LIVE EVENTS

This segment handles the design and manufacturing of large format jumbotron, scoreboards and certerhung videoboards for professional and collegiate stadiums and arenas. Daktronics is the industry standard with an 80-85% market share across the NFL, MLB, NBA and NHL. These are typically larger ($10M-$150M), customized projects that on average take >6 months to produce from design to delivery. Given the size per project, revenue contribution is lumpy. Sales are handled directly with Daktronics typically serving as the general contractor for installation. The Company has longstanding relationships with nearly all the professional sports franchises as well as architects and design firms. Recently completed large projects include Gillette Stadium main jumbotron (largest video screen of any US sports venue) and multiple display upgrades with additions across the stadium and Empower Field/ Broncos which undertook a similar renovation. There are several professional sports stadiums in various stages of construction, including Highmark Stadium in Orchard Park (Buffalo Bills), Intuit Dome (LA Clippers) and Oklahoma City Arena (Thunder). Daktronics has either formally been contracted to provide the video displays or is the incumbent provider of the team arena that is being replaced.

The segment is benefiting from a number of favorable dynamics. The most significant of which are accelerated upgrade cycles to larger, higher-resolution displays and a greater number of visual systems per venue. Historically, replacement intervals were +10 years but this has compressed to every 5-7 years. This has been driven by efforts to improve the viewer experience and attendance. Stadiums built 8-10 years ago were initially constructed with 1-2 large end zone jumbotrons and 2-3 scoreboards placed mid-field. Now arenas are built and upgraded with much larger jumbotrons, wrap-around ribbons and halo displays, marquee systems across the exterior and often +100 internal video boards in varying forms around the concourses and throughout the venue. This is done to enhance the viewer experience, level of engagement and attendance to an increasingly screen-oriented culture. The success of high profile, large format LED media venues such as the MSG Las Vegas Sphere seems to have created an incremental interest in the application of larger video screens. The latest generous of LED is much more flexible and customizable. Daktronics new curved screen innovations are impressive and have been well received in the market (there are many but here are a couple noteworthy recent examples: Intuit Halo and Western & Southern Open).    

At the collegiate level, display upgrades have been following similar trends. As one team in a conference undertakes a stadium improvement, competitors typically follow for sake of fan experience, recruiting and broadcast contract and league requirements. Such initiatives are typically financed by team revenue and alumni donors and are in part subsidized by future advertising revenue. Across NCAA football and basketball, broadcasting rights agreements have been setting records in the top conferences. There is a bit of a bifurcation across conferences, but this growing media revenue should be broadly supportive of program budgets and ongoing facility upgrades at the collegiate level.

Its only noteworthy competitor in the large format category is Primsview (fka YESCO, subsidiary of Samsung). Primsview has a high-quality product set that is commercially branded as Samsung following its acquisition of the business in 2017. In 2020, it won the contract for the Allegiant Stadium (Las Vegas Raiders) displays when it bid aggressively in order to gain exposure for the Samsung name which is displayed on a stadium’s jumbotron. This competitor has struggled to gain traction in the large-scale display market due to quality and performance issues. Our research indicates customers lost confidence in Primsview over the last couple of years due to delivery delays and a lack of replacement parts (ongoing supply chain issues from Korea-based manufacturing facilities). An industry consultant noted, “Daktronics has the best image quality and reliability in the industry…they have cemented themselves as the go-to for pro sports and live entertainment venues.” In addition to service and quality superiority, Daktronics’ incumbent position is protected by onerous permitting and bondholder requirements that would be required of a new entrant.

In the smaller sporting displays, Daktronics’ most noteworthy competitors are Formetco and SNA Displays. Within post-secondary and secondary schools, Daktronics’ primary advantage comes from its operating systems (Show Control System and Venus Control Suite) which operate the scoring board and display content. These controls provide flexibility in showcasing diverse content, such as live feeds, social media updates, event schedules and promotional messages. This versatility enables schools to adapt to different sporting events and cater to specific audience preferences. As the industry standard in professional sports live digital operating systems, schools select Daktronics over peers so communications students seeking careers at the professional level can gain experience on its platforms.

HIGH SCHOOL PARK & RECREATION (HSPR)

This segment is comprised of scoreboards and internal displays to elementary through high school and communities. Strong municipal financial conditions boosted by record tax collections and Federal aid programs have driven an acceleration in the building of new facilities, school renovations and an upgrading of scoreboards and live sports and other scholastic displays. As of September, educational construction new starts per Dodge Data were up 60% Y/Y and 29% on an LTM basis. This follows near record growth last year and should be supportive of ongoing demand for Daktronics products. Scoreboards are also frequently financed by boosters and in many use-cases generate an ROI derived from advertising revenue. Similar keeping-up-with-neighbors dynamics are at play here as local taxpayers prioritize spending on educational facilities to support their home values, among other things. This is a more competitive market with various regional players including Scorevision, Nevco and Translux. Daktronics competes on the basis of its superior operability and durability and product support.

Approximately 80% of sales in this category are standardized displays with the rest being custom-built configurations. This segment has been consistently growing sales in the high teens and likely will see an acceleration based on the previously mentioned demand factors. It generates 30% gross margins and 20% operating margins, making it the highest margin category after transportation. These products are sold primarily through distributors. Orders are often placed with shorter lead times and thus a good portion of revenue that is ultimately realized does not ever get recorded in its reported quarter-end backlog.      

COMMERCIAL

This division is focused on 1) on-premise signage (interior displays within a retail location) and 2) off-premise/ OOH billboards and advertising displays. The increased demand, broader adoption and expanded application of these screens has been driven by improved functionality/ adaptability, lower LED unit cost, upgrade cycles by retailers and demonstrated ROI in certain applications, particularly advertising.

Off-Premise

Off-premise customers consist of the larger OOH advertising companies such as Lamar (LAMR), Clear Channel (CCO), JCDecaux (DEC) and Stroeer SE (SAX) as well as regional land owners and property management companies. Nearly all sales are direct to the end customer. Based on disclosure by public customers, only 3-5% of billboards have been converted to digital. There has been an ongoing effort to drive conversion given the attractive ROIC profile to OOH operators. Digital displays allow, in many cases, the replacement of 2-3 segment static boards with one digital display with eight customers on that one display. It allows more flexibility to change the content, particularly to optimize around the likely viewer at a given time of day. Permitting and other factors have been an impediment to this transition but overall it should be supportive of ongoing growth in adoption. There are relatively few competitors in this vertical. We estimate DAKT has a 30-45% share of the market domestically.

Customers have noted a preference for Daktronics given local support, access to digital billboard parts, reliability and service network. Per one customer, “they [Daktronics] have the least downtime of any brand and that brings comfort to OOH operators.” This has been an area of accelerating capex deployment by the public outdoor advertisers. For what it is worth, Magna Media Forecast forecasts spending in the category to grow 13.5% CAGR through 2027 (the fastest of all advertising).

Per primary research, "Daktronics makes outstandingly reliable pieces of equipment…billboards... they are tremendously good from a build quality standpoint. In terms of reliability and service network. They have the least downtime of any brands and that brings comfort to OOH operators.” Among the currently installed digital boards, many of the parts are no longer available from its peers thus necessitating replacement. A large national OOH advertising company noted, “if I built a display 10 years ago, I can't even get the components for that anymore because they're obsolete and the manufacturers of those components no longer make them.” This challenge has benefited Daktronics given its track record of support and as the only US-based manufacturer. Many of the digital billboards in the US are reaching an end to their useful life. While there are few new billboards being installed nationally, Daktronics should benefit from the ongoing replacement and upgrade cycle for the foreseeable future.

On-Premise

The other component of the Commercial segment is on-premise. These are interior displays within a location such as a retail, gas station and restaurant chains, convention centers or casinos/ entertainment centers. Approximately 75% of sales in the Commercial category are standardized displays with the rest being custom-built configurations and service-related revenue. Larger sales are handled directly, but the majority are through distributors and resellers that are incorporating Daktronics signage as part of a bigger package.

Growth in the segment is being driven by the replacement of print boards and smaller, limited functional LCDs with larger LED displays. An increase in the cost of print boards and associated re-fixing at all points of sale has made the economic logic of moving to displays incrementally more compelling for retailers. Meanwhile, consolidation, industry trends and an accelerated use of technology has led to nearly continuous refresh cycles.

TRANSPORTATION

This segment is dedicated to wayfinding signs and increasingly advertising displays in airports, parking lots, train stations and roadways/ mass transit (ie. lane closed or alternative routing signage). Drivers of demand are infrastructure construction, airport renovations/ expansions and the overall broader usage of digital ad displays across transportation hubs. Customers range from government mass transit departments to airlines, airport operators and contractors. Daktronics’ largest competitors are Telegra, LG, Skyline and SESA, almost all of which are rebranded products sourced from China.

INTERNATIONAL

This is a small segment for Daktronics. It has been depressed due to a slower recovery in spending in Europe. Management has been making changes to improve and stabilize the segment. Gross margins steadily improved over the last four quarters and operating margins have inflected positive. It is now making a positive contribution to earnings after having been a drag since 2021.

BACKGROUND & PROFILE CHANGE

Daktronics second generation CEO was historically more reactive and focused on the premium tier of the commercial market. This constrained its market opportunity, particularly within the commercial and high school categories. DAKT has maintained its position as the provider of the highest quality (best service and technology, most durable and only US-based manufacturer) but over the last four to five years the Company expanded its product set to include offerings at lower-tiered price points to meet the budgets and needs for a broader base of applications. Note, this has been done while increasing its margins in the segment.

Meanwhile the Company has undertaken various improvement initiatives which have improved it margins, FCF profile and overall business profile. This includes investment in automation over the last 2-3 years, supply chain improvements (consolidated supplier base), SKU and inventory rationalization and associated working capital needs, price increases and improvements to its product mix toward higher margin, higher growth categories. This has only come to bear in its financial results over the last two reported quarters.

FINANCIAL PROFILE & ESTIMATES

During fiscal 1H’22, pretty much everything went wrong for Daktronics. This included production inefficiencies, cost overruns due to inflation on large, fixed-price contracts, some product shortages which delayed delivery and revenue recognition and bearing the cost of a CRM upgrade and automation investments. Financial performance began to improve in FQ3’23 and more materially in FQ4’23 and FQ1’24 as Daktronics worked through its backlog and realized the benefits of its improvement initiates as well as the launch of new products and economies of scale. In May, the Company increased its line of credit with JPM Chase to $75M concurrent with a capital infusion from Alta Fox by way of a convert (Alta Fox is also a 5% shareholder). This refinancing materially upgraded its capital structure and alleviated its prior liquidity constraints. 

Revenue with Live Events can be lumpy from quarter-to-quarter given the size of some of these projects. To estimate revenue, we assume a moderation in consolidated growth to 5% over the next three quarters following a concentration of deliveries/ catch up in FQ4’23 and FQ1’24, partially offset by completions to be realized in FQ2 and recently announced new projects. This FY2024 growth rate is predicated on the following unit-level revenue change over the next three quarters: Commercial +10%, Live Events -15-20%, HSPR +10%, Transportation +5% and International +5%. Thereafter, the Company will likely experience a reacceleration in growth driven by the previously discussed factors. There are several new professional stadiums under construction and planned for development. Daktronics won the contract for the Intuit Dome (wrap around halo and all displays in the venue) and is well-positioned to secure others as the legacy video board provider to each franchise. All present large-scale opportunities for the Company over the coming 1-3 years. Stadium retrofits and new builds across the expanding MLS should be further supportive of Daktronics backlog.

On the cost structure front, gross margins ex-D&A grew from 17.3% and 19.2% in the first two quarters of F2023 to 27.0% and 32.6% over the last two reported quarters. We have assumed 29-30% gross margins off this base after factoring in some seasonality in sales (Q1 and Q2 being higher volume sales periods than Q3 and Q4). SG&A is essentially fixed as Daktronics does not compensate internal sales personnel based on commissions with the most recent quarter representing the most appropriate baseline following the overhead changes it made last year. The Company has committed to spending 4% of revenue on R&D. Daktronics has been spending heavily on automation over the last two years. Management believes there is more opportunity to improve margins through further automation but capex is anticipated to moderate to approximately 3% of revenue over the next year or stepping down from $25M in FY2023 to $20M in FY2024 and $15M in 2025. 

VALUATION

On a fully-taxed basis, DAKT is on track to generate $1.25-$1.45 of cash EPS in FY2024. This equates to an approximately 7-8x EPS or an 10-14% levered FCF yield based on the current share price. For sake of perspective, DAKT trades at 6x the last two quarters earnings on an annual basis (the period following the normalizing of operations). We have presented the LTM above to illustrate why the stock does not appear statistically attractive when screened (as the period is burdened by the previously noted two quarters of business challenges).

The public comp set is limited with the closest peers in terms of products being Acuity Brands (AYI), Hubbell (HUBB) and LSI Industries (LYTS). All of which currently trade at 12-16x forward earnings multiples with an arguably larger skew to less attractive commercial segments than DAKT. The broader commercial construction services and equipment sector trades in the mid-to-high teens. On an absolute basis, DAKT’s current trading multiple is disconnected from its current financial profile, market position and growth trajectory. At a more appropriate 12-15x EPS multiple, the stock would trade at $18-22 per share or 70-100% above its current price.

As the discussed catalysts unfold over the coming quarters, DAKT’s multiple and stock price should increase commensurately. There is a relatively large potential set of logical strategic acquirors ranging commercial products OEMs such as Samsung, Panasonics, Acuity Brands and Hubbell (HUBB) to engineering services and construction companies like Fluor (FLR) or Tetra Tech (TTEK). All trade at high-teens to mid-twenties EPS multiples, making a potential acquisition of DAKT at +$25 per share accretive.

OTHER INVESTMENT CONSIDERATIONS & RISKS  

• Live Events revenue is by nature chunky given the large size per project and thus subject to a higher level of amplitude in change from quarter-to-quarter.
• Samsung: While Samsung’s performance in large event installations has been mixed, it could bid aggressively for future contracts in order to gain commercial placement of its brand name in arenas.
• Commercial Construction Slowdown: C&I lending activity will likely be a headwind for office and other sub-segments of the market. The Company has very limited exposure to that area of commercial construction and overall new building. All Daktronics end-markets remain very strong. 

Catalyst

1. A higher appraisal of its share value as Daktronics demonstrates the sustainability of its recent financial performance supported by the: 1) new product launches and strong backlog; 2) recent operational and cost structure improvements; 3) lapping of CRM upgrade costs; and 4) a step-down in capex as automation investments are completed over the next couple of quarters. This will yield a higher FCF and earnings profile.
2. The next reported quarter is an easy comp which will also improve how DAKT screens statistically on an LTM basis.
3. Sell-side initiations and increased corporate outreach to expand investor awareness of this opportunity.
4. Potential sale given its strategic value and appeal to private investors.