Viavi Likely To Benefit From Smartphone Sensor Market Growth (NASDAQ:VIAV)

Viavi Solutions (NASDAQ:VIAV) recently noted its expectations with regard to new R&D investments in the 3D sensing and smartphone sensor market, and confirmed restructuring efforts in 2024. If we also take into account internationalization efforts and recent increases in EPS expectations, VIAVI does look like a buy. Yes, I identified some risks with respect to the total amount of debt, competition, or failed restructuring. However, VIAV appears to offer upside potential in the stock price.

Viavi Solutions

Viavi Solutions offers solutions for network testing, monitoring, and assurance, serving various sectors such as communications service providers, network equipment manufacturers, and governments.

Its focus on instruments, automation, intelligence, and virtualization appears to be empowering customers. VIAV also covers anti-counterfeiting applications in various sectors. Operating in key segments such as network enablement, service enablement and security as well as performance optical products, I think that the company has already demonstrated its versatility and leadership in the technology market.

Its dedicated sales force works closely with customers to understand design, performance, and cost requirements. In the Optical Security and Performance Products segment, it focuses on markets such as consumer electronics, government, and automotive, using global sales forces and teams of applications engineers.

In the last quarterly report, Viavi noted better than expected EPS normalized of $0.11 and better than expected net sales of $254 million. With that, I believe that the most remarkable is that analysts out there increased their EPS expectations for 2024 and 2025. There appears to exist a certain optimism in the market.

Balance Sheet, And Cost Of Debt

As of December 30, 2023, the company reported cash and cash equivalents of about $543 million, short-term investments of about $25 million, and accounts receivable of $208 million. Besides, with inventories of about $115 million, total current assets stand at about $965 million, and the current ratio is close to 2x-3x.

In addition, with property, plant, and equipment of close to $236 million, goodwill worth $455 million, and intangibles of $48 million, total assets are worth $1.856 billion. The ratio of total amount of assets/total liabilities is larger than 2x, so I believe that the balance sheet appears quite stable.

I am not concerned about the total amount of liabilities because the total amount of debt decreased significantly. In addition, the debt/EBITDA ratio lowered significantly in the last five years. From 8x EBITDA in 2019, the ratio declined to close to 2x-4x from 2021 to 2024.

Accounts payable stands at about $43 million, with accrued payroll and related expenses worth $46 million, deferred revenue close to $60 million, and short-term debt of close to $96 million. Total current liabilities stand at about $312 million, and long-term debt is worth $632 million.

For the assessment of the WACC, I took a look at the interest rate included in the senior notes, which stands between 1% and 3.75%. Viavi Solutions issued $250 million of 1.625% Senior Convertible Notes due 2026 in a private offering in March 2023. An exchange transaction, recorded as a modification, was completed, reducing the carrying value of the 2024 notes and generating a compensatory increase. The 2026 notes bear interest at 1.625% payable semiannually, and may be converted under certain circumstances. With these figures, I believe that assuming a WACC between 4% and 8.5% makes sense.

Assumption #1: Restructuring Events May Accelerate Profit Margin Growth

It is worth having a look at Viavi’s expectations with respect to its restructuring plan, which resulted in gross cost savings in 2023, and may do the same in 2024. Under my base case scenario, I assumed that Viavi will successfully see some financial gain out of these efforts.

The Company’s restructuring events are primarily intended to reduce costs, consolidate operations, integrate various acquisitions, streamline product manufacturing and address market conditions. The Fiscal 2023 Plan resulted in an estimated annualized gross cost savings of approximately $25.0 million excluding any one-time charges as a result of the restructuring activities. Source: 10-Q

The second phase of the Fiscal 2023 Plan is primarily focused on reducing costs in our SE segment and the Company anticipates this phase to be substantially complete by the end of fiscal 2024. Source: 10-Q

Assumption #2: Internationalization Could Bring Net Sales Growth

I believe that it is worth noting the company’s efforts mainly in Europe, where I detected an increase in the percentage of total revenue. The company is also present in Asia and other regions in the Americas. In my view, further internationalization efforts and international diversification will have a beneficial effect on future net sales volatility. Besides, economies of scale may also arise from the fact that Viavi is operating in many different markets.

Assumption #3: New Smartphone Sensors Could Bring Net Sales Growth

Viavi Solutions follows a corporate strategy focused on maintaining its leadership in test and measurement instruments, as well as anti-counterfeiting and light management technologies. Besides, it seeks to increase its market share in test instruments for 5G, fiber, and 3D detection.

In the last quarter, the company noted its expectations with regard to R&D investments in new 3D sensing and smartphone sensors. In my view, new products or new capabilities will most likely bring demand from clients. As a result, we may see an increase in the net sales expectations.

We expect to continue to invest heavily in R&D in order to expand the capabilities of 3D sensing and smart phone sensors, handheld spectrometer solution and portable test instruments, introduce new products and features and build upon our technology. Source: 10-Q

Market experts believe that the smartphone sensors market could grow at a CAGR of 17.8% from 2023 to 2030. Given these expectations, I believe that the demand for Viavi’s stock could increase.

Smartphone Sensors Market Size was valued at USD 110.71 billion in 2022 and is expected to reach USD 410.61 billion by 2030, and grow at a CAGR of 17.8% over the forecast period 2023-2030. Source: Snsinsider

DCF Model Under My Base Case Scenario And Using Previous Assumptions

My expectations under this case scenario include 2031 product revenue of about $291 million, 2031 service revenue worth $229 million, and total net revenue close to $520 million. Finally, with 2031 net income of about $35 million, I assumed a profit margin of 6.8%. I believe that these figures are conservative and in line with previous figures reported in the past.

With 2031 net income of about $35 million, I also assumed the following adjustments to reconcile net income. 2031 depreciation expense was assumed to be $38 million, and stock-based compensation stood at $59 million, with amortization of debt issuance costs and accretion of debt discount close to $12 million and 2031 deferred taxes worth $38 million.

In addition, other assumptions include changes in accounts receivable of about $285 million, 2031 changes in inventories worth $23 million, 2031 changes in accounts payable of about -$70 million, and changes in deferred revenue of close to -$71 million. Finally, with net cash provided by operating activities of about $325 million and capital expenditures of about -$21 million, I obtained 2031 FCF of about $305 million.

Under this case scenario, my results are shown below. I assumed a terminal EV/FCF multiple of 18x FCF with a WACC of 4%. Note that Viavi traded in the past at close to 25x FCF and 31x FCF, and other competitors traded at close to 20x sector median. With this in mind, I believe that the exit multiple of 18x FCF appears conservative.

Finally, the implied enterprise value would be $5.075 billion, with equity of $4.9 billion and an implied price of $22 per share.

Risks That I Included In My Worst Case Scenario

In my opinion, Viavi Solutions faces risks associated with restructuring activities, including delays in personnel reductions and possible failures to meet operational objectives. Management and talent retention transitions generate uncertainties, affecting operational results and customer relationships.

In addition, changes in management could make recruiting for future management roles more difficult. Competition for technical talent is intense, exacerbated by the relocation of headquarters to Chandler, Arizona, and the increase in remote work. I also believe that the company’s inability to attract or motivate talent could negatively impact the company’s financial performance.

I also think that increases in the interest rates may harm future net income growth. Besides, in my opinion, under my worst case scenario, Viavi may not be able to finance future operations, which may lead to higher cost of debt and cost of capital. Shareholders may sell their shares as the implied stock valuation could decline.

DCF Expectations Under My Worst Case Scenario

Under my worst case scenario, I included the following financial projections. 2031 Product revenue would be close to $141 million, with 2031 service revenue of about $95 million and total net revenue close to $236 million. I also assumed 2031 net income of about $16 million with profit margin of about 6.8%.

Under this scenario, I also included depreciation expense of about $1 million, with amortization of acquired technologies and other intangibles close to $11 million, stock-based compensation worth $5 million, and amortization of debt issuance costs and accretion of debt discount of about $7 million.

In addition, financial projections also include changes in accounts receivable of close to $140 million, changes in inventories of $37 million, changes in accounts payable of -$51 million, and changes in income taxes payable worth -$28 million. Besides, with 2031 accrued expenses and other current and non-current liabilities of about $35 million, 2031 net cash provided by operating activities would be $127 million. Finally, with 2031 capital expenditures of about -$7 million, 2031 FCF would be $121 million.

Under the previous conditions, with a WACC of 8.5% and 2031 EV/FCF of 15x, the implied enterprise value would be $1.3 billion. Adding cash and subtracting debt, the equity valuation would be $1.1 billion, and the fair price would be $5 per share.

Competitors

Viavi Solutions competes in the network enablement sector with prominent rivals such as Anritsu Corporation (OTCPK:AITUF), EXFO Inc., Keysight Technologies Inc. (KEYS), Rohde & Schwarz, VeEX Inc., and Spirent Communications plc (OTCPK:SPMYY). Although it faces intense competition in each product line, I believe that the company stands out as having one of the most comprehensive portfolios of wireline and wireless products in the network enablement industry. In my view, this approach allows it to offer varied and robust solutions, positioning it as a key player to satisfy the diverse needs of clients in the field of networks.

My Opinion

With better than expected quarterly net sales growth and quarterly EPS actual, Viavi may soon bring the attention of more investors. I also believe that the restructuring efforts expected and the growth of the 3D sensing and smartphone sensor market could bring significant net sales growth in the future. In my view, there are risks associated with restructuring, the debt obligation, and intense competition that also require the attention of market participants. However, I think that the upside potential in the stock price appears more significant than the downside risks.