Megaport Limited: Key drivers within management’s control
About the author:
- Author name:
- By Nick Harris
- Job title:
- Senior Analyst
- Date posted:
- 10 February 2023, 8:00 AM
- Sectors Covered:
- Telecommunications, Technology
- Megaport Limited's (ASX:MP1) 1H23 result was already largely known as it released its December 2022 quarterly in January. There was not a lot of new information in today’s update. Consequently, we make immaterial changes.
- Investors want to see sales accelerate and MP1 become free cash flow positive. We do not expect a short-term acceleration in sales (due to global macro economic weakness and company-specific events). However, we do think MP1’s path to becoming free cash positive within the next ~18 months looks substantially de-risked and the key drivers are within management’s control.
MP1’s result was broadly in line with expectations and figures released with MP1’s quarterly in late January.
Forecasts and investment view
Our underlying EBITDA forecasts are largely unchanged. Our FY23 FCF forecast (burn) is reduced while working capital changes increase our FY24 FCF burn. Overall changes are timing related and not material.
Our investment view, Add recommendation and (login to view) target price are retained.
We understand the market’s concerns around slowing sales momentum. However, we think this is macro environmental, as well as being related to short-term, company-specific events. We do not think it is indicative of broader problems. The global economic slowdown is starting to bite and businesses are naturally reluctant to make significant investments in this uncertain environment.
The bulk of MP1’s connects are to Cloud Service Providers (CSPs). Its sales rates have slowed materially in the last two quarters. December 2021 QoQ growth was 36% and this progressively decelerated to 23% QoQ in December 2022. See overleaf for more details.
Once the dust settles, we think MP1 is well placed to return to double digit sales growth. Its new Chief Revenue Officer should also hopefully start moving the sales dial. In the meantime, existing customers should continue to purchase more of their telecommunications needs off MP1 and grow MP1’s revenue (MP1’s case studies and cohort analysis shows this is a key driver of sales growth).
On the new customer front, we think MP1’s value proposition - increased flexibility, avoiding material long-term commitments and a lower total cost of ownership (TCO) - should resonate with businesses looking to improve their own operational efficiencies. SaaS companies typically spruik a ~30% lower TCO than legacy options. We think MP1’s TCO savings are greater than this. Its offering should be increasingly attractive to customers in an economically challenging environment.
Management’s focus is fixed cost leverage and margin expansion to deliver profitable growth. This is a relatively lower risk way to get the company to a self-funded position quickly and is based on drivers that are largely within management’s control.
MP1 ended December 2022 with US$39m of cash. 1H23 annualised cash burn was US$34m including US$3.7m of vendor finance, or US$42m excluding it. The three key changes announced at MP1’s Q2FY23 result will collectively decrease annual cash burn by ~US$16m. This nearly halves cash burn to US$25m (pre vendor financing). The full benefits of these changes should be realised by July 2024, with gradual improvements likely to be seen in Q4 FY23. Revenue and gross profit growth should deliver strong fixed cost leverage and further reduce FCF burn.
These three key changes are all lower-risk ways to improve MP1’s financial trajectory as they are within management’s control. They are: 1) repricing a single legacy offering (not the whole MP1 price book) +US$6.4m; 2) telco COGS savings from cross connect and equipment consolidation (US$6.8m); and 3) capex savings of US$3m (with key projects completed capex declines). This is based on the mid-point of guidance and a 75c AUD/USD.
On our updated forecasts MP1’s cash balance dips to US$15m before the company starts generating positive FCF and this balance begins to grow.
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