Radisys (RSYS) shares are up 1% year-to-date, which relative to the Russell 2000 makes it look like a big winner. That being said, we believe the stock is extremely cheap (more than mere optics would suggest), and, like many other micro/small-caps, seems to have ongoing selling pressure. In addition, the company had upside to 4Q and raised guidance for 2016.
The company has two disparate businesses, a low-margin, highly profitable, embedded computing division, and a fast growth, high margin, but currently unprofitable software and systems division. In our view, the stock is a story of 1+1= ½ – with the sum of the parts worth less than each unit individually.
In 2015, Radisys earned $0.21 (non-GAAP), exceeding the guidance it laid out at the start of the year for the first time in quite a long time. When the company reported 4Q, they guided 2016 EPS of $0.22-$0.28, which at the mid-point implies almost 20% EPS growth. But, in our view, that’s far from the whole story.
In 2016 the company guided that the embedded division will grow – in part due to a one-time $19 million win – however they also stated they expect y/y growth for embedded in 2017. Embedded, rather than being a melting ice cube (it has been declining for several years) is a now a highly profitable, growing, segment of the company. Rather than being worth perhaps 3-5x EBITDA, embedded is likely worth 7-8x or more.
Several years ago the company considered strategic options for this business. We don’t think anything is imminent, but we believe the company would be a willing seller at the right price. We suspect that Embedded, ex-software/systems losses, probably is a business earning $0.30-$0.35. That is inexpensive, in our view, for a growing business at a company trading for $2.81 with over $0.20 per share of net cash. It would suggest the software/systems business is free (or even being attributed a negative value).
With software/systems benefiting from strong secular tailwinds, and top-tier partners like Nokia, Reliance (India) and, we believe, AT&T, we think the segment is extremely well positioned. Comps to Radisys’ software/systems business trade at 2.5x-3x revenue or more, so with Radisys guiding to over $60 million in sales in the segment, it would imply $4-$5 of additional value.
We recognize that prior to 2015 Radisys was a frequent source of investor disappointment (turnarounds can take time), but if the company delivers in 2016 the way it did in 2015, we think there is a significant opportunity for sentiment to change. If it does, we think Dane has the opportunity to capture a 2-3x return. We also note that multiple insiders and Board members made open market purchases in 2H 2015, at prices well above levels where the stock was trading at in 1H 2015 (there were additional insider buys post 4Q results), in our view suggesting increasing confidence in the company’s prospects as the year progressed. We also note that the single factor most tied to management’s options vesting is the achievement of higher share prices – clearly there is significant investor/management alignment.
The above post has been excerpted from a letter of Dane Capital Management.
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