Ubiquiti Networks - Definitely Different, But With Uncertain Prospects

By Stephen D. Simpson, CFA | October 02, 2012 AAA

Every so often, an investor will come across a company that flummoxes them, and Ubiquiti Networks (Nasdaq:UBNT) is one such company. I love the idea of providing attractively priced wireless equipment to developing countries and exploiting the gap between broadband demand and capacity. On the other hand, the company's model is unconventional, to say the least, and recent issues with counterfeiting may well highlight some of the serious risks of that model. Overall, Ubiquiti ends up looking like a classic high-risk/high-reward story - if it works, it will work very well, but if it doesn't, there won't be many places to hide.

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Connecting the Disconnected
As any Cisco (Nasdaq:CSCO) can attest, networking gear isn't free and it can cost a lot of money to build out a broadband network. That's particularly relevant in emerging markets, given the dichotomy between the cost of imported equipment from more conventional companies such as Cisco, NetGear (Nasdaq:NTGR) and Ceragon (Nasdaq:CRNT), and what service providers can charge customers for broadband service.

So this is where Ubiquiti comes in - they focus on wireless equipment packages (including radios, antennas, software, etc.) that work outside and allow providers to enhance broadband access via unlicensed spectrum. Perhaps equally to the point, this equipment offers appealing price/performance characteristics for the buyers and about 70% of the company's sales come from outside the U.S.

A Different Corporate Approach
The idea of selling wireless equipment, even equipment at an appealing price, isn't really new, but Ubiquiti's corporate structure/philosophy is definitely different.

Instead of a direct dedicated salesforce, the company relies on a community of network operators, service providers and distributors to essentially act as a virtual salesforce. Likewise, the company leans heavily on this community when it comes to product development.

As you might imagine, there are both perks and drawbacks to this approach. It definitely saves money, and it's pretty clear that Ubiquiti passes along some of those savings (in some cases, users have reported that Ubiquiti's prices are one-fifth of competing options). It also arguably helps customers feel more united and appreciated. On the flip side, Ubiquiti doesn't offer the same level of after-sale support, and allowing others to carry your message means you sacrifice control of that message.

Control Is Becoming a Real Problem
Ubiquiti's structure sacrifices a lot of corporate control, and that seems to have come back to bite the company. There have been some cases where Ubiquiti equipment ended up where it shouldn't have - Iran, specifically - and while it doesn't seem the company knew this, it does show what can happen when control devolves away from the center.

Likewise, the company has recently seen some major problems with counterfeit airMax equipment. Not only are counterfeiters stealing business that would have gone to Ubiquiti, but it is also leading some customers to slow down/halt orders (since they're not sure they're going to get the genuine article). While the company is fighting back, its options are limited - the company likely needs to redesign the hardware to lock out future counterfeiters, and though the company's legal efforts have had some success (including seizures, arrests and frozen assets), this is an expensive game of international whack-a-mole. As a sign of how serious this problem has gotten, management said it could strip as much as one third of sales out of the next quarter's revenue.

Ongoing Progress Despite the Noise

Ubiquiti's CEO Robert Pera arguably hasn't done shareholders any favors with his announced intentions to pursue the acquisition of the NBA's Memphis Grizzlies. While it's not as though he's looking to use corporate resources to do the deal, it has attracted a lot of attention from external commentators who view it as a distraction at a time when the company really needs help.

SEE: Analyzing An Acquisition Announcement

On a more positive note, Ubiquiti has stayed active on the product development front. There have been three significant platform launches so far this year, with the latest (edgeMax, a new routing platform) joining airFiber and mFi.

The Bottom Line
With a 52-week trading range of roughly $8 to $36, it's clear these shares are volatile. Moreover, investors who may remember the ups and (mostly) downs of UTStarcom (Nasdaq:UTSI) could be forgiven about another tech company looking to build a business around emerging market telecom/networking gear

For my part, I think both the market and opportunity are real. I do believe there is strong unserved broadband demand outside the U.S. and I don't think Cisco is in any hurry to match prices with Ubiquiti. On the other hand, the company's reliance on distributors is problematic, as is the company's decision to recognize revenue on "sell in" instead of "sell through." Likewise, the ongoing sequential growth in accounts receivables worries me and makes me wonder about the real health of the sales channel.

SEE: 5 Must-Have Metrics For Value Investors

Not surprisingly, the range of possible outcomes here is larger than normal. If Ubiquiti can become a $1 billion revenue company by 2012 (roughly 10% annual compound revenue growth) and maintain free cash flow margins in the 30% range, these shares are easily worth more than double today's price. But if the company cannot get a handle on this counterfeiting issue, if inventory is backing up at distributors, or if growth forces the company to adopt a more conventional corporate structure, there could be ample downside even from these levels.

At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.

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