Megaport Limited: Slower than hoped but direct is priming the channel
About the author:
- Author name:
- By Nick Harris
- Job title:
- Senior Analyst
- Date posted:
- 22 April 2022, 8:30 AM
- Sectors Covered:
- Telecommunications, Technology
- Megaport Limited's (ASX:MP1) Q3 result was weaker than we had expected. This was due to a combination of currency (which halved revenue growth on translation back to A$) and the fact that many of MP1’s direct sales people are currently “hand-holding” channel partners – teaching them about MVE and how to sell it.
- All major MVE / SDWAN resellers have live MVE’s so channel is slowly gaining sales momentum. This means MP1’s direct sales people will be able to refocus in direct sales in Q4+.
- MP1 is leading the market with MVE. When building a market leading product, in a relatively new market (like SDWAN), it takes time and a lot of effort to educate partners and customers on the value the new product offers. Initially this can be slow and painful. This hard work can create a substantial first mover advantage / network effect which creates large barriers to entry and great businesses.
- We remain convinced that MP1 has global potential. That said, investors need to see proof points of the scalability, so a lot hangs on a sales acceleration.
- We reduce our forecast and our Target Price falls to (login to view). Hold retained.
Q3 result snapshot
ARR was up 3% QoQ in A$ and up 6% QoQ in constant currency. Cash operating costs were up 1.6% QoQ and capex up 23%. Given chip/supply chain issues, MP1 brought forward ~6 months of capex, and inventory increased by ~$10m.
Being a trail blazer comes with a slow start but momentum is building
The currency impact was most notable. The stronger A$ effectively halved the rate of sales growth (on translation). Even after taking this into consideration, constant currency, revenue growth was weaker than we had expected.
The bear point from Q3 is that, after virtually doubling the sales force in the last twelve months, YoY revenue growth (in dollars) has slowed in the last two quarters. In constant currency terms, MP1 added $585k of MRR in Q3FY22 versus adding $631k of MRR in Q3FY21.
A similar trend was also evident in Q2FY22. Expectations are for an acceleration so the key question was why is it slowing?
The reason MRR growth has slowed relates primarily to MP1’s direct sales people “hand holding” channel partner sales people. As the world leader in SDWAN, MP1 has built and is experienced in selling, world leading products. However, MP1’s channel partners are not yet.
Equally the end customer is not intimate with the value proposition and how it can help their business. Consequently, a significant amount of MP1’s sales effort has been diverted from direct sales to training channel partners sales teams to promote highly scalable channel sales in the future.
The bull point from Q3 is that all of the top 5 SDWAN players (covering ~70% of the market) are selling and have live MVE’s. MVE sales will accelerate from here.
The channel is primed and now selling. Direct and indirect sales should accelerate QoQ and all going to plan revenue should accelerate in Q4 and again in FY23.
Forecast changes
We lower our revenue forecasts by 5-10% in FY22 and FY23. Given the fixed cost leverage, our EBITDA declines a larger amount.
Investment view
We are long term bulls on MP1 given structure tailwinds, unique business model and its growing competitive advantage. However, we are conscious of the changing investment environment (rising interest rates are clearly driving a rotation from growth to cyclical stocks that are inflation beneficiaries).
MP1 is valued on long term growth assumptions and in the short term trades on a multiple of revenue. Consequently its valuation is very subjective and shareholders need to be prepared for very high share price volatility to remain.
Price catalysts
The key catalyst for MP1 is proof points to an acceleration in sales.
Risks
MP1 is a high-growth business and as such is subject to significant share price volatility. This includes a share price highly sensitive to bond yields and inflation. All other KPI’s unchanged, rising interest rates, results in lower valuations.
MP1, like most high growth stocks has suffered a de-rating as the tech sector has been sold off, fighting this macro trend will be challenging in the short term.
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