Description

Investment Summary:

Radisys (RSYS) is a leader in enabling wireless infrastructure solutions for the telecom, aerospace and defense markets which enables RSYS’s customers to bring high-value products and services to the telecom market faster with lower customer investment risk.  On July 30, 2013 RSYS announced a messy restructuring and transformation process to create value for the long future.  The restructuring and lack of visibility has created an opportunity for longer term value investors.

When Brian Bronson, former CFO took over as President/CEO in October of 2012 he indicated that he and his team would conduct a thorough but quick evaluation of RSYS’s strategic direction. The overall conclusion “do fewer things and do them better” by focusing on the MRF product line while leveraging the “world renowned”  Trillium Software line as well as other software solutions. This realignment comes at the expense of noncore products which may still include selling noncore businesses. Overall, the goal is to simplify the company while focusing allocation dollars at higher growth and higher margin businesses.

• Software-Solutions business is expected to grow +20% going forward and margins are estimated to be in the high 60s.

RSYS currently trades at 0.4x EV/2014 (midpoint sales guidance of $245MM) which is a significant discount to the group average of 1.8x. Acme Packet was acquired by ORCL for ~5x EV/Sales and Broadsoft which currently trades at 4.4x EV/2014 sales serve as good proxies for the value being placed on the future of the wireless ecosystem. These comparisons are not “apples to apples” but a modicum success of RSYS’s high growth strategy provides meaningful equity upside from current levels.

• The growth dynamics of the software businesses combined with cost structure initiatives should result in RSYS’s target financial model of ~40% gross margins, 10% operating margins and $240MM to $250MM in 2014 revenue.

A fair and reasonable valuation for RSYS over the long term of 0.8x EV/Sales equates to a ~$6.90s target with potential upside on the successful outcome to the transformative plan.

Highlighted Segments:

The platform segment is the major flaw in the RSYS story, which should be labeled the “melting ice cube” chapter. RSYS’s plan is to make the platforms business profitable which for the most part includes hardware. A majority of the ATCA hardware products are software enriched and is a requirement as the market transitions to software defined networks (SDN) or network function virtualization (NFV). This segment is at a $200MM run rate and operating at a loss. The new target cost structure is to be profitable at $170MM run rate over the next three years.

Platform revenue breakdown by product line and future forecasts:

• ATCA $130MM going to $140MM
• COMe and Rackmount Server $45MM going to $30MM
• Legacy CPU$25MM continues its decline to zero

• “We are going to make all of our businesses profitable.” Brian Bronson, President/CEO July 30, 2012

The Software-Solutions produces provide customers with a comprehensive suite of solutions to address their network needs. The future of RSYS is highly dependent on the following two product families:

Media Resource Function (MRF): RSYS’s line of market-leading, software rich MRF products enables innovation and differentiation by providing powerful, reusable and highly scalable multimedia processing platforms for audio and video conferencing, VoLTE, VoIP (Video over IP), IMS telecommunication service providers, solution developers, OEM and enterprise customers. RSYS believes their MRF products support the next generation of feature rich, revenue-generating services that combine the best of the Internet and telecommunications worlds.

MRF enables the convergence of fixed and mobile networks by delivering a shared IP media processing resource for any access network, including 4G/LTE wireless, broadband, cable, public switched telephone network (PTSN) or satellite. The system’s multi-service versatility enables service providers and their application development/network infrastructure partners to rapidly deploy innovative high-margin telecommunication services.

• MRF’s current annual run rate is $30MM and profitable; management’s goal is double it in the next 3 years.

Trillium Software: RSYS’s Trillium software protocols and application frameworks are the underlying signaling and data infrastructure that enables the communication for many generations of telecommunication networks, including mobile and fixed line networks. The current focus is on enabling 3G and LTE wireless network access. In addition, Trillium supports all types of network infrastructure from access to the core of the network to wireless to wireline networks.

Trillium software is the foundation for many 3G and LTE small cell products. Small cells enable mobile operators to increase capacity, improve coverage and reduce the cost per bit of data traffic as the demand for mobile services has increased dramatically.

• Trillium’s current annual run rate is $20MM and close to breakeven; management’s goal to grow +20% a year with solid profitability. 
• The pipeline for Trillium’s license and professional service opportunities entering the second half of the year increased over 40% from the level it was at the beginning of the year.

Macro Drivers for RSYS

• The continued global deployment of next generation LTE wireless network that provide carriers the needed bandwidth to meet the exponential growth in network traffic brought about by the proliferation of wireless devices at network worthy speeds.
• The telecommunication industry’s ecosystem continues to evolve as telecommunications equipment manufacturers (TEMs) focus more on additional applications and network operations and carriers focus more on service and content delivery.
• Projected data traffic increases are driving the need for wireless network providers to both decrease the cost and increase the efficiency of their wireless networks through the following:
  • Lowering the cost per bit of data transferred over wireless networks
  • Increasing average revenue per users (ARPU)

Nierenberg Factor

David Nierenberg is the largest RSYS shareholder with 15.77% of the shares outstanding and has been on the Board of Directors for 2.6 years.  Nierenberg is a very successful investor in both turnarounds and venture capital; both skills are highly needed in this investment. His involvement and guidance will be instrumental in RSYS’s future success.

It is also interesting to see the following cluster of insider buying:

• Board of Director: Kevin Melia bought 25K in 12/11 ranging from $4.21 to $4.27; second longest tenured Board member with 10.2 years
• Chairman of the Board: Charles Gibson bought 27.9K @ $4.35; longest tenured Board member at 10.9 years

Balance Sheet note

• July 29, 2013: RSYS signed an amended agreement with Silicon Valley Bank extending our $40MM line of credit through July 2016.

Catalyst