HLIT Price $6.55

Mkt Cap $662m

Net cash $171m

TEV $491m

2014 Revenue $487m

2015 Revenue $523m

TEV / 2014 Revenue = 1.0x

TEV / 2015 Revenue = 0.9x

2014 EBIT $37.2m

2015 EBIT $62.5m

TEV / 2014 EBIT = 13.1x

TEV / 2015 EBIT = 7.8x

 

Harmonic Inc is a leading supplier of cable and broadcast equipment to its customers and is about to experience cyclical growth in addition to significant addressable market expansion through a new product introduction.  Harmonic has traditionally been a cyclical supplier to the cable industry dependent on new video standards to cause its customers to refresh their Harmonic products.  Video standards such as MPEG-2 and MPEG-4 have driven cable and broadcast customers to upgrade as each progressive standard was more efficient than its predecessor, allowing the customers to transport more video (and audio) though their available bandwidth.  These upgrade cycles have driven revenue growth at Harmonic to 20% for two year periods followed by declines of smaller amounts until the next cycle. 

 

Harmonic is currently in the trough of the MPEG-4 cycle that drove its revenues in 2010-2011.  The upcoming major cycle is for HEVC which can double the amount of content transported per unit of bandwidth, and will be necessary as operators begin to show 4K content, which is the next step up from HD.  Even before HEVC goes mainstream in 2015, Harmonic has some tweaks on MPEG-2 and MPEG-4 which it has begun selling recently and is getting some traction with customers.

 

The big secular growth driver in the Harmonic story is the transition of devices at the cable edge from CMTS to CCAP.  Harmonic has traditionally been the leading player at the cable edge transmitting video downstream to cable customers.  They were not involved in the much larger market (5x larger) of transporting data upstream and downstream to cable modems in the end-customers homes.  What has happened over the past couple of years is that a standard has been developed for an integrated device that would handle both data and video at the cable edge, called a CCAP.  Harmonic has approached this market with the video expertise while Arris and Cisco has approached with the data expertise.  So far both Harmonic and Arris have been earlier to release products than Cisco and both are gaining share in this market.  This market is expected to take off in 2015 but Harmonic has already begun shipping product to customers.

 

Harmonic has invested a lot of money in R&D for its new CCAP products.  The company now realizes it is at the end of an investment phase and will strive to keep growth in opex to a minimum while growing the top line and expanding operating margins.  While the company had historically not returned capital to shareholders, this changed last year and the company has repurchased $140m of stock since. 

 

So why does Harmonic trade at 1x sales given these cyclical and secular revenue growth drivers and attendant improved profitability?  I believe most potential shareholders want to wait until these growth drivers show up on the company's P&L, instead of gaining confidence in them beforehand and getting a significantly lower entry price.   

The main catalysts are the HEVC and CCAP product cycles which are beginning now but will ramp up in earnest in 2015.  The tweaks to MPEG-2 and MPEG-4 will benefit the company between now and then.  I think that Harmonic is also a pretty good buyout candidate given its low valuation and its market leadership in its product segments.  Arris and Cisco could be suitors to quicken their ability to add the video piece to their CCAP boxes.