IPO watch - Calnex (LON:CLX)

You might think 2020 is not the year to float your company, but the truth is there are a few recent IPOs on the market. In fact by my counting, there have been close to 20 this year. That’s lower than last year but it’s still plenty of new entrants.

There is a wariness around IPOs - why buy something being sold to you by investment bankers when they have much more information than you do? But there are always exceptions to the rule, and every once in a while this lack of information can result in a great opportunity for the diligent investor.

Here are some of the more notable IPOs this year in order of listing date:

We covered Inspecs (LON:SPEC) here although it’s safe to say, with everything else going on this year, I haven’t kept up with developments. The group announced a £64m placing on 19 November that will be used to help pay for the £84.7m acquisition of Nuremberg-based eyewear supplier Eschenbach.

That’s a material development for the £268m market cap Inspecs and is probably worth a closer look in itself. But for now I’d like to focus on Calnex Solutions (LON:CLX) - the clear standout from the list above in terms of share price performance.

Calnex (LON:CLX)

Share price: 99.8p

Shares in issue: 87,500,000

Market cap: £87.3m

Calnex makes hardware and software solutions that test the performance of critical telecoms and data network infrastructure. It’s an important function in a rapidly evolving and expanding industry, and Calnex is trusted by many of the world’s leading operators.

We can see revenue, operating profit, and free cash flow are all growing at decent rates (albeit over just a three-year time period):

It is profitable, cash generative and entered FY21 with a record order backlog. That sounds promising - my only real question right now is: is it too expensive after a 100% rise, or is there still plenty of upside left on the table?

The group has a Value Rank of just 17 and, while that Rank is often harsh on Technology stocks, there is also a forecast PEG of 3x. That’s way above the 1x or less GARP investors typically look for.

That aside, Calnex shows some promising double-digit Quality metrics:

And the market dynamics look positive (more on these points below).

Calnex has built up a position of trust with global customers and regulators. This provides it with excellent product development visibility and it has developed a useful track record of introducing first to market testing solutions. That dynamic makes Calnex a useful and entrenched player in this market, with commercial testing solutions and a highly relevant R&D pipeline.

That might go some way to explaining the high returns on capital. These testing solutions are also often quite complex, which could enhance pricing power and operating margins.

There has certainly been plenty of interest from the investment community so far, with the share price doubling in just a couple of months.

Business structure and history

Calnex is headquartered in Linlithgow, Scotland but it also has a base in Belfast with a development team following the acquisition of JAR Technologies in 2018. A US office manages sales channels, including sales teams in China and India, and supports customers throughout the world.

The group provides its equipment to many of the world’s leading Telecoms Network Operators (including BT, China Mobile and NTT), Equipment Vendors (including Ericsson and Nokia) and Component Manufacturers (including Intel and QualComm). It reports across three geographic regions: Americas, North Asia, and Rest of World (including UK).

There’s a high level of repeat demand in this business. Over the last three years around 80% of revenue has come from returning customers and the group’s ten largest customers (which accounted for 52% of revenue in FY20) have on average a nine-year relationship with the company.

These sales are predominantly derived from Telecoms customers, although Calnex does have some notable non-telecoms customers - namely technology giants like Facebook, Google and IBM.

Calnex also outsources a lot of its manufacturing and distribution to high quality local partners, freeing it up to focus on product development and IP.

Summarising its history briefly:

• Calnex was incorporated in Scotland on 27 March 2006 by CEO and major shareholder, Tommy Cook.
• In 2007 it’s first product, Paragon, was launched to address an emerging need to test the synchronisation of telecoms base stations. These base stations are telecoms towers which manage the radio connections to mobile phones.
• In 2012, the company released its network emulation product, Attero, which is used to impair data traffic to verify that applications and transmission protocols can robustly respond to transmission problems across networks.
• In 2013, Calnex acquired Sentinel, a technology operating as a portable platform for testing synchronisation during maintenance testing post-deployment. This enabled Calnex to offer test solutions from design through to post-deployment maintenance test and debug.
• In March 2018, Calnex acquired JAR Technologies, securing the IP relating to SNE and the company’s development team. SNE is a PC-based network emulation solution offering multi-user capability for low bandwidth applications. In the first year of trading post-acquisition, sales of SNE increased 5-fold as Calnex made use of its global sales channel.

That last point is important to prospective investors. Calnex is entrenched in the telecoms ecosystem. It has also built up a considerable sales network. This strong market position allows it to quickly integrate, scale up and cross-sell value-added testing solutions.

The telecoms market

There are a couple of key drivers of change in the global telecoms market right now. One is the migration of the mobile networks to 5G, a second is the emerging Internet of Things, and a third is the shift to cloud computing. Calnex can drive sustainable revenue growth from each of these trends.

The global market for mobile network testing alone has been estimated by Frost & Sullivan to be around $1.3bn in 2020, and is forecast to grow at a CAGR of 11.5% and exceed $2bn by 2024.

The same consulting firm estimates the global high speed ethernet test equipment market to be around $1.3bn in 2020 and also expects this market to grow to $2bn by 2024.

Key participants in the telecoms industry include:

• Equipment Vendors like Huawei develop hardware and software systems for Network Operators like BT.
• Component Manufacturers such as Intel sell components and sub-assemblies to Equipment Vendors.
• There are also Hyperscale/Large Enterprise entities, such as Facebook, Google and IBM, that build and create their own networks and equipment.

All of the above businesses are customers of Calnex.

Recent trading and outlook

The above certainly sounds intriguing, and the group has already updated the market on trading post-IPO, so let’s take a look at its results so far.

Interim results, 25 November 2020

Highlights:

• Revenue +37% to £7.7m on a gross margin of 78.1%.
• Adjusted PBT +90% to £2.3m,
• Net cash from operations +98% to £2.8m.

Customer order intake was strong, with increased demand across all product ranges and continued high levels of orders from repeat customers, supplemented by the addition of new customers.

Cenkos has upgraded its forecasts on these results, with revenue forecasts for FY21 and FY22 by 10.6% and 12.2% to £15.4m and £16.4m and increased forecast EPS up 24.1% to 4p and 14.3% to 3.9p respectively.

Calnex is investing in both R&D and sales capacity to capture market share, with 5G, the Internet of Things, and cloud computing all driving demand for high value test instrumentation in the years ahead. One reason for the IPO was to enable the group to make more acquisitions, so there’s also growth potential there.

But is a 100p share price just paying too high a price for this promising prospect? A forecast earnings per share figure of 4p suggests a forecast PE ratio of 25x. That’s not overly demanding for a growth stock, but then Cenkos is forecasting a slight drop in earnings per share the following year.

Forecasts aside, the group’s founder, CEO, and major shareholder Tommy Cook will likely be looking to expand. There are certainly some eye-catching growth drivers in this market, and Calnex looks to occupy a privileged position as a trusted tester with good product roadmap visibility.

And alongside these organic drivers, we also have scope for targeted acquisitions now that Calnex is listed. It has proven with JAR Technologies that it can drive value in this way.

Conclusion

There are signs of promise here.

Calnex has a high quality and growing customer base of leading telecoms network operators, equipment vendors, component manufacturers, and other large enterprises, with a high level of repeat custom.

It has proven that it can drive value from acquisitions with its established global network of partners and distribution capability. The group spends generously on research and development, and has also proven its ability to develop innovative and advanced test solutions. Products are often high spec and complex.

Group R&D is informed by its insights into customer technology roadmaps and likely regulatory developments. Those relationships have been earned over time, meaning it can anticipate market demand. All of the above taken together make for some notable barriers to entry.

The admission doc states that the historical revenue CAGR since FY15 clocks in at c16%, and there is a record order backlog and strong sales pipeline going into FY21.

And there is the market itself: an exciting time in telecoms, with 5G, the Internet of Things, and the shift to cloud computing all creating substantial opportunities in the medium term. We have the likes of Slater Investments on the share register. I would speculate that that kind of institutional investor is looking for substantial growth, and the group’s founder and CEO remains its biggest shareholder.

But then we have the unavoidable fact that this is a recent listing, with much less information available on historic trading.

And the share price has doubled. If we take the above 16% revenue CAGR and take that forward, along with the group’s 3y average profit margin of 15% or so, we get the following:

It’s worth noting that Cenkos forecasts a higher adjusted EPS figure of 4p for FY21 so there’s a good chance the above table is too conservative. Nevertheless, it suggests that today’s share price is factoring in good growth and that Calnex is now fairly valued rather than cheap.

That coupled with its newness to the market is enough to keep me on the sidelines for now, but I’m curious to know what others make of Calnex. And then there are the other recent listings in the table above - do subscribers see any big winners there or are we better off waiting for these operators to prove themselves as listed companies?