Description

Quick Summary

KVHI is a provider of connectivity for the marine industry and inertial navigation for  the defense and transportation industries.  The stock is mispriced because investors are underestimating the impact of 4 different inflections in KVHI's businesses which would make long-term results dramatically different that current numbers.  Furthermore, 2019 revenue has been weaker than expected due the shift to AgilePlans that has hurt near-term revenue due to lower initial product sales and a cyclical weakness in inertial navigation sales.  However, long-term revenues could be multiples of current levels if they take advantage of some of these revenue opportunities.  While downside should be somewhat protected near $7.90, upside could exist as high as $22 which makes it an interesting risk-reward at $10.

Capitalization and Valuation

KVHI has ~18.5mln diluted shares for a $185mln market cap at $10.  The company currently has $48mln of cash but will probably burn ~10mln for a future EV of 146mln.  2020 sales are expected to be ~177.5mln (0.8x) and 2020 EBITDA is ~4mln (37x although EBITDA is a bad metric because of the capitalization of equipment under AgilePlans. 

Upside

There are 4 sources of upside for KVHI.

1.  AgilePlans- In 2017, KVHI began offering AgilePlans which are connectivity-as-a service.  Instead of selling the communications equipment upfront and then collecting airtime fees, the company retains the equipment and offers everything on a service package to the shipping customer.  These plans have allowed KVHI to take more market share as the marine industry transitions from L-Band (432kbps) to VSAT (up to 10Mbps).  Analysts estimate there are 30k vessels that currently have VSAT and 35k vessels without VSAT that will be transitioned over the next few years because of the significant advantages for vessel operations and crew communications provided by VSAT.[i] 

There are 30k L-band ships out there.  If the company adds another 5k subs at $1,200/mo ARPU (below expectations), then it would add ~another 70mln of AgilePlans revenue.

2.      KVH Watch- In 2019, KVHI launched KVH Watch, an IoT maintenance service for marine equipment suppliers (engines, scrubbers) that would allow them to remotely monitor and maintain their equipment, saving significant service costs.  The company has just begun a trial with first customer Kongsberg and should begin to roll-out this service in 2020. The goal of the equipment is to have multiple customers per vessel.  If KVHI was able to sign up 1k vessels with 3 tenants at an average of $400 per month, it would be 14mln of incremental revenues.

3.      TACNAV- KVHI has been shortlisted on the US Army A-PNT project for inertial navigation.  The US army is looking to upgrade >140k vehicles with its new A-PNT initiative which could be a >$100mln revenue opportunity.[ii]  The company is also expecting a large order from Saudi Arabia.

4.  Autonomous Vehicles- KVHI has invested in creating photonic Fiber Optic Gyros (FOGs) for autonomous vehicles which are potentially a critical component to help them maintain position.   KVHI's photonic FOGs are important because they help lower the cost of FOGs to where they can be mass produced for automotive and other transportation uses.  The company claims to be in ~80-90% of autonomous prototypes on the road and recently noted that it is on 30-35 different autonomous vehicle platforms.[iii]  These chips will enter into their first production products in March of this year.

While success here remains very uncertain, this is a potential opportunity for 2mln units+ at $150 ARPU or a $300mln business.  KVHI has described this market as a potential $3bln TAM.[iv]

Adding low-end revenue estimates from these projects and it is possible to see revenue more than doubling.  With a 40% incremental margin we could see EBITA increase to ~51mln.  Obviously this is a very rough estimate but I believe it shows the potential for significant upside here.

Using a 12x multiple on EBITA, that would suggest a share price of $34 which would be ~$22 discounted back 3 years at 15% (due to the higher risk).

Downside

KVHI has a strong balance sheet with ~$2.70 per share of net cash and ~$6.90 per share of tangible book.  The company's inertial navigation and marine connectivity service revenue area also valuable assets and should garner a decent revenue multiple.  Creating an SOTP valuing the assets on 2019 results and burdening the company for 3 years of corporate burden suggests a share price of ~$7.90 per share.

While I generally consider SOTP based valuation to be purely theoretical, I would argue that it is more realistic in the case of KVHI.  Founder Martin Kits Van Heyningen only owns ~5% of the shares outstanding and activist firm Vintage Capital owns ~9.5% and has nominated two board candidates in February for the 2020 election.  Thus, if the company does not take advantage of some of these revenue opportunities then I believe there will be pressure to realize value from some/all of the assets and would argue that there would be strategic interest in both Inertial Navigation (other FOG companies and defense contractors) and Mobile Connectivity (other marine broadband providers). 

[i] The Complete Guide to VSAT 2019

[ii] 2019 Investor Day

[iii] https://www.newportri.com/296ee985-1a8a-5d14-bd25-4982593914d8.html; KVHI Q4 19 CC

[iv] 2019 Investor Day

Catalyst

1) Increased Agile Plan Sales

2) KVH Watch revenues

3) TACNAV Sales

4) Autonomous vehicle FOG sales