Is Aerohive (HIVE) an undervalued acquisition candidate?

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HIVE has been beaten up since its March 2014 IPO and the situation is now heightened as activist investor and orphaned public company savage Discovery Group filed a 13D on June 19, 2015 and has continued to buy, making HIVE a top 5 all-time investment.

Activist Highlights: Discovery Group 

  1. 58 activist targets. Small-cap focused, average target market cap of $205M. Heavy in tech, healthcare.
  2. 50% of targets have been acquired, including 3 of 4 targets in HIVE’s comms equipment industry.
  3. Continued purchases make HIVE the #5 all-time largest investment. Cost basis is now $7.91, above the current price of $7.33.
  4. Interesting trend8 of last 10 targets IPO’d within the 4 preceding years of the activist campaign. These companies struggled out of the gate, with all but one trading below its IPO price, and at a significant discount ranging from 25-65%. Investors in new public companies are fickle, and should companies miss guidance, lower growth forecasts or post poor operating results, the stock is quickly dumped. Without investor support, research analysts drop coverage and the former IPO darling becomes an orphaned public company toiling in small cap purgatory. Orphans often lack the scale and resources to compete with larger competitors and valuations depress, creating a ripe acquisition candidate. The frothy Tech IPO market has enabled IPOs for companies that may have not gotten out in less favorable times, and some of these companies are not yet ready for public scrutiny. Those that falter fit in perfectly with Discovery’s activist playbook.

HIVE Highlights:

  1. IPO’d at $10.00, and after missing guidance, slower growth and operational struggles, is now trading ~25% lower than the issue price.
  2. Unprofitable earnings and cash flow, with a quarterly break-even revenue target of nearly $50M (that has been creeping higher). Highest quarterly revenue to date is $37.6M.
  3. Revenue diversification: Education (40%), Enterprise (40%), Retail/Healthcare (20%); 40% international.
  4. Net cash balance of $65.4M can withstand unprofitable ops and comprises 18% of market cap.
  5. Revenue multiple valuation is in-line with competitors such as Cisco, Ruckus Wireless (also beaten up post-IPO) and slightly below Aruba’s buyout multiple.

Acquisition Target?

The play here is Discovery Group pushing for an acquisition. Let’s evaluate if HIVE makes a good candidate.

Dislikes:

  1. 40% of revenue stream largely dependent on government distributions toward education programs like e-rate. The timing of e-rate funding has been been pushed multiple times, further depressing the stock.
  2. Tough competitive environment. HIVE has ~10% market share in a WiFi market dominated by Cisco and Aruba (now HP). Cisco has 50%+ share. Cisco typically wins by wrapping wireless products into a larger networking bid and VARs noted if a networking RFP is $10M+, they don’t bother responding with pure-play suppliers like HIVE. Aruba is traditionally focused on large enterprise, Ruckus on carriers. All competitors are chasing the same verticals.
  3. Cisco and Aruba have greater resources, scale and sales reach. Smaller customers are drawn towards Cisco / Meraki’s products and larger customers to Aruba’s Instant. Aerohive will increasingly need to compete on price and software capabilities, which will be costly to overall margins that are already deep in the red. And both Cisco and Aruba now offer controller-less solutions, eating away at HIVE’s tech differentiation.
  4. Promotions and discounts for products are frequent to stay competitive, not great for an industry with guerrillas.
  5. Management is apparently content with 10% market share. This quote from the Q4’14 earnings call is depressing: “…our estimate that our share is in the low to mid-teens in this market…and our expectation would be, at this point, primarily to maintain share in this market rather than necessarily expand it. There are certainly more people that are going to be paying attention to the E-rate business…there’s no reason we can’t increase share over time, but with other people putting increased focus on this segment, maintaining share would be a successful outcome.”
  6. Accounting shenanigans like capitalizing R&D costs, but starting in Q2’15 were moved to the income statement.

Likes: 

  1. Industry M&A activity, with HP/Aruba acquisition in May 2015 and Meru Networks being put out of its misery by Fortinet in July 2015. Cisco acquired cloud-provider Meraki for $1.2Bn in 2012, which appears to be a solution refresh that is cannibalizing Cisco’s legacy on-prem solution.
  2. Good technology (controller-less, cloud-managed mobility platform) that significantly reduces the cost and increases performance relative to competitors. Reduces hardware requirements and simplifies network management.
  3. Validation of tech through partnerships with Dell, Apple and wins at over 22K customers.
  4. Despite missteps, still a growing company in an attractive industry. Can grow software and services segment, but the margins are even lower than the product revenues.
  5. Digestible market cap of $350M and net cash position pushes enterprise value under $300M.
  6. Rationale for either a direct competitor to consolidate share or an out-of-segment player to gain exposure to WiFi market.

Alt Activist Take: Aerohive’s negative operating model and competitive hurtles to growth are somewhat mitigated by its technology. With industry M&A and an activist that specializes in pushing orphaned small caps toward an acquisition, HIVE’s public company days are numbered. As valuation is relatively in-line with competitors and recent M&A precedents, and growth has slowed, I don’t imagine an acquiror would pay a massive premium above its current trading price. Could I see a buyer matching its IPO price for a ~30% premium? Absolutely. Question is if HIVE’s board would accept such a proposal. I’m sure Discovery Group will encourage them to do so.

Financial Snapshot + Activist Breakdown

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