Huawei's Challenges Are a Boon to Adtran
Dec 22, 2020 by InvestorDestination Team
Nowadays, the market is offering high valuation for technology companies that provide products or services to enable remote access. Adtran (NASDAQ: ADTN) is a technology company that provides products for broadband access. However, it is not generating high enthusiasm in investors. The last time this company had a high valuation was before Comcast's Slowsky (a character in Comcast's ad) mocked slow DSL speed.
Adtran is a global provider of networking and communications equipment. It is a conservatively managed company. As the world moved away from copper to fiber connection in the last decade, Adtran slowly transitioned from copper-based network products to fiber access products. Recently it started generating more revenue from Fiber products than copper.
COVID has ignited the demand for remote access and governments, and service providers will continue to invest in broadband. There is a strong demand for fiber in the foreseeable future. In that case, why are investors not excited about Adtran?
During its slow transition, it looked like the company took one step forward and two steps backward. That can be blamed on the lumpiness in its business. Network service providers use Adtran's products, and it generates a majority of its revenue from a few Tier 1 customers. Its revenue is highly dependent on these top customers. Adtran's revenue and margins slump substantially whenever one of its top customers pause their capital spending. In the last few years, the company has experienced this lumpiness a few times. So, despite the strong demand for fiber, investors are cautious about Adtran's growth trajectory.
Adtran is diversifying its customer base and trying to reduce dependency on any one customer. Now it generates more than 30% of its revenue from its Tier 3 customer base. The Tier 3 customer base consists of hundreds of alternative service providers. In general, reducing revenue concentration and increasing diversification of customer base comes at increased SG&A cost. As we mentioned earlier, it is a very conservatively managed company. The management has done an excellent job of diversifying the customer base without increasing its SG&A expense.
The company is not abandoning its Tier 1 customer base; instead, it is trying to increase that number and reduce the dependency on any one customer. Governments' restrictions on Huawei are helping Adtran to acquire new Tier 1 customers in Europe. Recently the company has acquired major awards from three such customers. However, due to the nature of the business, every award may not result in revenue, but some will generate material revenue for the company.
Due to the nature of its business, Adtran will have revenue concentration. However, its diversification efforts will lessen the impact of slowness in any one customer. Investments in Fiber and Huawei's challenges are acting as a tailwind for the company. The company has a strong balance sheet. When its revenue declined substantially, it successfully reduced its operating cost and continues to pay dividends. It will reward its patient investors.
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