Wednesday, May 3, 2017

A current AIM Fund holding: PCTEL (PCTI) by Joseph Amoroso. “Weak Connection. PCTEL in Critical Condition”

PCTEL, Inc. (PCTI, $7.75): “PCTEL Investment Thesis in Critical Condition”
By: Joseph Amoroso, AIM Student at Marquette University

Disclosure: The AIM Equity Fund currently holds this position. This article was written by myself, and it expresses my own opinions. I am not receiving compensation for it and I have no business relationship with any company whose stock is mentioned in this article.

PCTEL, Inc. (NYSE:AIG) provides performance critical telecom solution for wireless networks. The company operates across North America, Asia and Europe with two product segments: Connected Solutions and RF Solutions.

• The proliferation of Small Cells, 5G, and the Internet of Things (IoT) represent exciting growth opportunities for PCTI.

• Contrary to expectations, revenue mix has not changed since first being added to the AIM portfolio.

• Company has experienced significant customer consolidation.

Key points: Performance Critical TELecom is ripe for removal from the AIM Domestic Small Cap portfolio. PCTI has ultimately fallen away from the drivers of its original recommendation and with an extremely impressive month of price performance behind it, is in a positon to be trimmed before the AIM class of 2018 leaves for the summer.

As we look ahead to the expansion of 5G, management is very optimistic about the positioning of the company in being able to capitalize on the next big jump in wireless networking. Due to the higher frequencies of a 5G network, these frequencies travel much short distances which inherently creates the need for more small cells. Small cells mark a change away from traditional macro cell towers which broadcast network access across a wide distance. 

Conversely, small cell allows for many small and densely placed cells to together provide widespread access. This operates the same way MU Wireless operates with all of those small white boxes placed in the ceiling tiles all across campus. Management expects small cell shipments to more than double by 2020 which would result in more than 10M units being shipped. It is anticipated that by the very nature of 5G, high frequency and short distance, 10x the number of base stations will need to be employed in order to handle the network as opposed to the existing 4G infrastructure.

Originally, the company was pitched under the prediction that the company’s higher margin business, RF solutions, would rapidly begin to grow as a share of total revenue moving towards 2020. Ultimately making up nearly 50% of total revenue. This represented a significant driver of revenue growth and margin accretion. However, the revenue mix has stayed about the same with RF solutions representing 32% and Connected Solutions representing 68% of total revenue in fiscal year 2016. Instead, significant growth is coming from within the company’s Connected Solutions business where antennas used in wireless devices and cellular networks represents the company’s top growth market. 

Management has made an effort to divest itself of lower margin businesses over the past few years, but the key migration to RF representing a greater percentage of total revenue has yet to materialize.
Finally, another significant driver for the company was that they had a diversified customer base. However, the company recently announced that Huawi, a key Asian customer, now accounts for more than 11% of total fiscal year 2016 revenue. Additionally, with the anticipated growth in small cell shipments companies such as China Mobile, Vodafone, and Verizon will continue to grow as a part of revenue.

What has the stock done lately?
In the last month, PCTI is up more than 30%. This was largely driven by a Sell-Side initiation from Lake Street Capital Markets at a price target of $8.00 and as a result of Wunderlich Securities raising their price target from $7.00 to $8.50 in addition to other macro variables. This recent support for the stock appears to be a unique exit point as some of the drivers behind the company’s original admission to the AIM portfolio continue to deteriorate. Furthermore, the company plans to release Q1 earnings on May 9th with consensus EPS of $0.03 which has the potential to result in increased price volatility.

Past Year Performance: PCTI has increased 72.32% in value over the past 12 months. After originally being pitched at a price of $5.96, PCTI proceeded to fall below $4.50 before experiencing significant upward momentum in 2017.

My Takeaway
Despite significant growth within the exciting 5G and IoT markets, the drivers for this company have not materialized as expected. A critical driver of margin accretion driven by RF solutions increasing their total share of revenue from ~30% to ~50% has not occured and connected solutions continue to remain the largest and fastest growing revenue source for the company, with RF remaining stable. Ultimately, I believe we have a unique opportunity to exit this position before leaving for the summer while still recognizing an upside of 29.53%.

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