Microwave Vision Group (MVG) is a French producer of scanners that allow the display of electromagnetic waves emitted by antennas. Put it differently, their products make electromagnetic waves visible. Antenna measurement is a growth market given the increasing number of different devices with antennas. Part of the company’s technology seems to be superior to the offerings of competitors. In addition, with each installed system MVG is increasing its recurring revenues. Uncertainty with regard to the allocation of capital recently raised is currently weighing on the share price. I also have one relatively severe concern with regard to the company’s accounting practice. However, the current modest valuation and the positive growth perspective speak for an investment in this company.
The need for antenna measurement systems
The need for microwave and antenna testing expanded rapidly during the 1960’s and 1970’s in conjunction with the growth and increased sophistication of the aerospace/defence industry in the United States and Western Europe. In the last 30 years, this need for test and measurement products has expanded beyond aerospace/defence applications to all aspects of modern telecommunications, including personal wireless communications devices, satellite-based communications systems and “smart” automobiles. This expansion has occurred in conjunction with a growing desire among companies to focus on their core competencies and outsource many non-core functions such as the development and manufacture of microwave test and measurement systems.
Within the wireless communications, satellite, automotive and aerospace/defence industries, test and measurement products are used during all stages of a product’s life cycle, including product development, pre-production qualification, production testing and product maintenance.
All products and systems that receive or transmit microwave signals rely on antennas. Accordingly, items such as microwave radios, GPS receivers, cellular handsets and base-stations, field service/delivery equipment, satellite earth stations and radios, precision guided missiles, radar and commercial and military aircraft need to have their antennas tested to ensure satisfactory performance characteristics.
Antenna measurement systems test for signal quality, direction, strength and interference. Antenna measurement systems incorporate a personal computer running specialized software, a microwave receiver, a positioning subsystem and at least one additional antenna or probe. The systems can be designed for use in a wide variety of different test environments, ranging from a small anechoic chamber to an outdoor range covering several acres.
MVG profits from a technology covered by several international patents
MVG is a pioneer in the development of antenna measurement systems. At first glance, the company seems to be an ordinary tech company. In general, most tech companies are under a lot of pressure from the fast technological progress/change and a highly competitive landscape and therefore need to continuously renew their product offerings. Therefore, for me it is mostly difficult to identify companies with enduring competitive advantages in this sector. However, from my perspective, MVG seems to be in a good competitive position mostly due to the patented multi-sensor technology the company owns. The following is an excerpt from the annual reporting:
“Unlike traditional mono-sensor technologies, which required long, fastidious mechanical movements, the MV-ScanTM scanners measure through numerous sensors. These electronically directed sensors drastically reduce measurement time by limiting mechanical movements. This reduction leads to a far better return on investment for the installations equipped with MV-ScanTM in comparison with those equipped with mono-sensor solutions … This technology is covered by several international patents. It allows Microwave Vision to propose a value-added offer to its customers.”
The antenna measurement systems segment generates more than 80% of MVG’s revenue
So the company claims to have a superior and patented technology in their largest segment, antenna measurement systems (AMS). Whether they can keep this advantage in the future is hard to predict depending on technologic progress and patent expiration. However, the company spends roughly 10% of sales for research and development (R&D). These expenses are mainly constituted by personnel costs with a total involvement of 70 employees (21% of total workforce) including 55 research engineers. In 2013 alone, the company launched half a dozen new products.
In addition to that, according to management MVG offers the most extensive range of antenna measurement solutions in the market based on modular elements. Due to the different needs of the customers, most microwave test and measurement systems (include proprietary software and hardware products) are not identical. However, MVG seeks to keep the costs of customization to a minimum by designing and delivering specific types of systems that maximize the use of the company’s off-the-shelf products. This approach shall enable the company to optimize its margins while offering its customers tailor-made solutions. Prices for a typical system range from USD 50,000 to USD 1,000,000, but large systems have been sold for over USD 3 m.
MVG’s offering extends from the analysis, sales, and design stages to production, integration, installation and support. These systems accounted for 44% of the AMS segment orders in 2013. Alongside these systems, MVG develops, manufactures and markets off-the-shelf products. These projects require little adaptation from one customer to another and can be rapidly commissioned. They represent 31% of AMS’s orders in 2013. Finally the Group offers engineering and maintenance services. They represented 25% of orders in 2013. A relatively large share of the company’s activity is based on regular contracts with repeat customers including measurement and maintenance services, updates of the solutions installed on-site and moving of facilities. These recurring revenues represent roughly 50% of sales within the segment.
MVG’s products are used in the research and development centres of their clients (50%), sold to subsystem manufacturers (30%) and system operators (20%) like military, airlines and service providers. Over the years MVG has won a number of well known companies as clients in the civil telecommunications, aerospace and defence industries like NASA, Boeing, BMW, Renault, Ericsson, Nokia and Panasonic. For instance, in the development stage of a new product the wireless functions of the antenna need to be tested and optimized. This means that the quantity of energy emitted by the antennae is measured, it is determined in what directions in space this energy is radiated, the quality of the information transported by the signals transmitted is qualified and the operation of the device in real environments is tested. Apart from that, it is noteworthy that the company has a diversified client structure with the largest client only providing 4% of revenue in 2013.
In 2014, the AMS business unit generated EUR 46.0 m of revenue or 81% of total sales. Operating margins for this segment are in the low teens. Management did break out revenues/operating income from multi and mono sensor technology only until 2012 (with the acquisition of Rainford EMC in 2012, they reorganised their segment reporting). The sub segments margins are in stark contrast to each other. While sales of the two technologies have been evenly split, multi sensor operating margins are five times higher than the mono sensor margins.
According to management expectations, the antenna measurement market will grow at an annual rate of 8% until 2018 and MVG has a 22% market share. Growth is expected to come from the increasing use of appliances with antennas and new technologies (e.g. new telecommunication standards). Satellites, planes, mobile phones, computers or touch tablets, connected vehicles, many medical instruments and wireless home technology are all converting electrical signals into radio signals. In addition, the transmission of information without human intervention called “The Internet of Things” seems to gain more and more traction. This constitutes another major potential for electromagnetic wave measurements and tests in the future.
One of MVG’s strongest competitors is ETS Lindgren (part of ESCO Technologies NYSE:ESE). In addition, there is a number of other small private companies active in the market. ETS makes roughly 40% of their revenues in the AMS market. The company is focused on the telecommunications sector. According to MVG, ETS is also offering multi sensor technology albeit based on a less advanced technology. Recently, MVG has been alleging ETS Lindgren of a patent infringement.
MVG expands to electromagnetic compatibility testing
Over the last years, the company set up a second segment focusing on electromagnetic compatibility (EMC) which offers aptitude test solutions for devices set to function in electromagnetic environments without producing interference themselves. For instance, in the automotive sector, the progress in wireless infotainment systems requires the carrying out of immunity testing in face of the outside environment (for instance for radars). The segment’s offerings also include the protection against strong electromagnetic fields and discharges (i.e. protection of data centres, protection against eavesdropping).
With the acquisition of British Rainford EMC in 2012, the company enhanced its product range in this segment. For instance, MVG offers a range of test chambers and faraday cages, the shielding of rooms, data centres and MRI installations and maintenance services. According to management, the company focuses on solutions with high added value to provide complex turnkey systems.
EMC tests are a prerequisite to many electronic devices and management estimates the current size of the market to be roughly USD 200 m growing at an annual rate of 7%. In 2014, the EMC business unit generated EUR 9.1 m of revenue or 16% of total sales. Operating margins seem to be a bit lower than in the AMS segment, but this might also be due to start-up and integration costs, which might be lower going further. The customers of this entity are R&D centres and certification organizations from a wide range of industries like defence, civil telecommunications, automotive, medical and IT infrastructure.
The most important competitor is again ETS Lindgren. In this segment ETS is roughly 10 times larger than MVG. So it is interesting that both companies challenge each other. While MVG has a more dominant position than ETS in the AMS market it is exactly the opposite in the EMC market.
Other innovations to diversify MVG’s product range
The company is also growing into other segments. In 2012, they introduced an inspection tool for industrial clients which uses microwave technology. Recently, they launched a solution for 4G connectivity called S@ILINK for the maritime industry. This product brings to the ship internet access up to 100 Mbits/s in a radius within 20 nautical miles (37 km). With costs of roughly EUR 1,000 per unit this is much cheaper than other solutions currently on the market. Apart from that, the company’s environmental control products measure the exposure to electromagnetic waves of workers and the general public. Moreover, the company is currently prototyping an airport scanner and a medical scanner for the detection and monitoring of breast diseases.
Microwave Vision consists of the affiliates Satimo Industries (100% stake), Orbit/Fr (63%), Aemi through Orbit/Fr and Rainford EMC (100%). In May 2008, French Satimo acquired the majority of US based Orbit/Fr and as a consequence Microwave Vision Group was formed. Through the acquisition of Orbit/Fr, Satimo complemented its product line and got access to other regions. Satimo’s patented MV ScanTM technology was combined with Orbit/Fr’s expertise in electromagnetic fields, measurement software, and positioning subsystems as well as AEMI’s absorbers, anechoic chamber design, and production facilities.
After the acquisition of Orbit/Fr, the company centralized sales and marketing and R&D leading to significant cost savings. Already in 2009, the company launched new products for antenna measurement, which combined Satimo’s probe arrays with Orbit/Fr’s positioners. The acquisition of Rainford EMC in 2012 targeted the further diversification of the product range and the access to the EMC market.
Management is currently working on integrating the different brands under one name. Recently, the company announced that Satimo will be renamed MVG Industries. In the case of Orbit/Fr, its shares were traded at the OTC Bulletin Board until 2012 when management decided to relist them on the lowest tier OTC market segment, the OTC Pink. This marketplace has no disclosure requirements. Nevertheless, management is still publishing Orbit/Fr’s annual reports. So, it will be interesting to watch, whether management buys out the remaining shareholders to further streamline the corporate structure. Orbit/Fr’s current share price is roughly 40% below the takeover price paid in 2008.
For the holding company it makes sense to look at the financial results from 2009 on, when Orbit/Fr was first consolidated:
1) Revenue generation and revenue recognition (a potential red flag)
Since 2009, revenue has increased at an annual CAGR of 10.3% and management is proud of 18 consecutive years of sales growth. MVG has a global footprint with revenues in 2014 coming from Asia (39%), Europe (34%) and North America (27%). However, the geographical distribution fluctuates each year with a tendency to revert to one third for each region. Currently, the US suffer from lower defence expenses, while Europe profits from a recovery in the automotive sector and Asia gains from the growth of mobile telecommunication. In 2014, revenue was evenly split between civil telecommunications, which includes the automotive sector and aerospace/defence segments covering land, air and space segments, whether civilian or military.
MVG generates revenues from the sale of products/studies and maintenance contracts. For the first part, management uses percentage-of-completion accounting. This means that revenue is taken into account progressively relating to construction progress. Accrued revenue (unbilled receivables) or deferred revenue are recorded based on estimated total revenues and the degree of progress (total costs realized at year end compared to the total cost forecast at the end of the contract). Generally speaking, this revenue accounting method gives management a lot of discretion and the opportunity for aggressive revenue recognition.
The following table provides a number of metrics. Combined, these metrics can hint to accelerated revenue recognition:
Unfortunately, the company only publishes accounts (including notes to the financials) on a yearly basis. As a consequence, I have no access to the quarterly numbers, which could be more meaningful.
DSO (days sales outstanding) shows an upward tendency in line with receivables as a percentage of total sales. However, what is really alarming at the end of 2013 is the sharp increase in unbilled receivables from EUR 7.8 m to EUR 15.5 m. This at least indicates that management might have overestimated the proportion completed in 2013, which might lead to a short term increase in profitability at the expense of future reporting periods. Fortunately, neither gross margins nor operating margins showed a strong uplift from 2012 to 2013. Nevertheless, the question remains whether the revenue increase in 2013 is mainly based on more aggressive estimates than in the years before. Therefore, this issue will be one of the first things I will look up in the upcoming 2014 annual report.
2) Return on capital
Return on equity or ROE ranged between only 5% and 9% over the last six years. However, looking at the balance sheet, most of the assets are made up of working capital (WC). In addition, goodwill as a result of the acquisitions made (Antenessa in 2007, Orbit/Frin 2008 and Rainford EMC in 2012) has a relatively high weight with 20% of total assets. Moreover, the company was holding almost no debt over the years, which generally has a negative effect on ROEs. Return on capital employed or ROCE (=net income / (non current assets – goodwill + working capital) looks not perfect but significantly better than ROE.
Overall, the relatively low returns and margins are also a consequence of the high R&D expenses (10% of revenues) and other investments in growth initiatives. However, like my other French investment Lectra, the company significantly profits from the tax credit for French companies with large R&D expenses. In 2013, this tax credit amounted to EUR 1.3 m (EUR 1.2 m in 2012).
3) Cash flow generation
WC grew in line with revenue and fluctuated between 31% and 37% of total sales over the period. WC decreased by EUR 2.5 m in 2011 and increased by EUR 2.0 m in 2012 and EUR 3.1 m in 2013. As a consequence, operating cash flow is highly volatile. There is no precise explanation in the financial reports why capital expenditures increased by EUR 1.5 m in 2013 and EUR 2.4 m in 2012 compared to 2011. Part of that increase can be attributed to the acquisition of Rainford EMC in 2012.
4) 2014 estimate
So far the company only released its 2014 sales figures. Final results will be published on April 30th, 2014. Therefore, apart from revenues I have forecasted the income figures for 2014. With regard to EBITDA, I expect a 100 bps increase in margins. To receive an estimate for operating income and net profit I use the average relation over the last four years between EBIT/EBITDA and Net Income/EBIT. Reason why I expect higher profitability is a significant improvement of the EBITDA margin in the first half of 2014 by 238 bps. The improvement in margins, resulted in part from the greater proportion that civil telecommunications have gained in the composition of revenues in the AMS segment, with the margins in this sector being higher than those of the aerospace/defence sector. For the full year of 2014, I also expect the revenue share of civil telecommunications to be significantly higher than in 2013.
5) Effect of capital increase
In July 2014, the company raised EUR 28.3 m by issuing 2.7 m new shares at a price of EUR 10.4 (current share price EUR 9.8) increasing the total number of outstanding shares to 6.3 m. Excluding the effect of the capital increase on the company’s equity and share count, I expect the company to reach an adjusted ROE of 9.4% and an EPS of EUR 0.99 for 2014. The prospectus provides valuable information about the company but is only available in French.
Reasons for capital increase
First, MVG intends to acquire one or more companies “generating between EUR 10 m and EUR 50 m in revenue, profitable or in the process of rapidly becoming profitable due to their integration within MVG, and present within the MVG value chain or in directly connected and synergistic sectors”. Around 80% of the net proceeds are budgeted for this purpose. After the capital increase, management has not yet published any progress in this direction.
Second, management needs to increase working capital in a context of an increase in orders. Around 10% of the net proceeds are budgeted for this purpose.
Third, the company wants to use 10% of the net proceeds to accelerate the R&D spending.
After the capital increase, MVG’s share capital is divided as follows:
Seventure Partners, a venture capital investor with assets under management of EUR 500 m, has been a shareholder since 2003. Before the capital increase, Seventure held 18.4% of the share capital and participated only partially in the capital increase.
With the capital increase, Bpifrance became a new shareholder and subscribed to 32% of the new shares. As a consequence, Bpifrance purchased preferential subscription rights held with the company’s executives, employees and Seventure Partners. Bpifrance with assets under management of more than EUR 20 bn provides financing to French companies.
Dr. Philippe Garreau joined Satimo in 1992. In 1996, he took over the management of Satimo and became CEO of MVG in 2008. Before the capital increase, he used to hold 6.0% of the company’s shares. Other employees are now holding 8.3% of the shares outstanding including the head of Orbit/Fr, the head of MVG’s R&D department and the managing director of Satimo (MVG Industries).
Before going public in 2005, the general assembly decided to provide double voting rights to shareholders, who were holding their shares for at least two years. Therefore, Seventure Partners and some of the employees have a larger voting power than their shareholdings would suggest.
Risks and uncertainties
One of the major advantages MVG has in place is their portfolio of patented technologies. Especially, the proprietary multi sensor technology seems to be very valuable to them. So any progress made by competitors in this field poses a threat to MVG. Not only competitors, but also internal development groups of existing customers can design their own microwave test and measurement systems. So MVG needs to be very careful to protect and keep their knowledge and resources inside the company.
As far as I understand, virtually all of the company’s contracts for its systems and products are on a fixed-price basis. The profitability of such contracts is subject to inherent uncertainties as to the cost of completion. In combination with a discretionary revenue recognition method (as mentioned above), shareholders have to be careful in examining MVG’s development of turnover.
In addition, there is substantial uncertainty regarding MVG’s external growth opportunities. The cash from the capital raise is still sitting on the bank account and potential sellers of acquisition targets might be aware of the pressure management faces to invest the capital which increases the risk that MVG overpays for a target. There is always a difference between managing a company successful and being a good allocator of capital. However, management was quite successful with the integration of Orbit/Fr. The acquisition generated significant synergies and helped to diversify and increase their product range and geographical footprint.
Apart from that, with the release of the 2013 annual report in August 2014, Mr. Garreau announced a sales target for MVG in 2015 of USD 100 m or EUR 75.3 m (at that time the EUR/USD rate was at 1.33). This would translate into a year-on-year increase in revenue of 34%. Obviously, without the support of external growth this ambitious target seems to be over the top. The longer it takes to find an adequate target company, the more unrealistic management’s forecast appears.
With Bpifrance the company got a long term oriented anchor shareholder. However, as this shareholder has a strong interest in supporting the French economy any potential strategic investor from abroad might be reluctant to invest in the company or provide an offer to other shareholders. Hence, returns for shareholders from “resource conversion” seem to be unlikely going forward.
Moreover, MVG is listed on the Alternext stock exchange which provides small to medium enterprises easy access to the equity markets with simplified listing requirements. For instance, MVG is only required to report the financial accounts including notes on the financial statements once a year.
Shortly before the capital increase, a closed end fund called Alto Inovation 5 was holding 6.1% of the shares outstanding. This fund is currently in the disposition phase. Based on their fact sheets, I assume that they have substantially reduced their position over the last months. Given that MVG is listed on the Alternext exchange, shareholders do only have to inform the public, when they cross the 50% and 95% holding thresholds. Possibly, ongoing sales from Alto Innovation 5 might have put some pressure on the share price recently.
More than 60% of revenues are coming from outside Europe. Production is located in France, Italy, Germany and Israel. The company does not hedge their currency exposure and should therefore profit from the weak euro.
Based on my 2014 estimates, MVG is trading at a 7.5x enterprise value to operating income multiple. The company is valued with 1.1x sales and has a price to book ratio of 0.9x. For a business that grew revenue at a 10% rate over the last 5 years combined with rising profitability (and margins at high single digit numbers) this seems to be a good deal.
I doubt that market participants have recognized the progress MVG made recently. I expect the release of the 2014 numbers to be a positive surprise. Therefore, I am accumulating a position now despite my concern about the 2013 revenue recognition estimates applied by management.
There are a couple of other issues that might distract potential buyers. For instance, investors screening for opportunities might reject MVG immediately given that the share is trading for a price to earnings ratio of 17.2x with the company only generating a return on equity of 6.8%.
However, this perspective is misleading as the company is sitting on a large pile of cash. How will the capital available be allocated? What I know is that management has experience in integrating acquisitions successfully and that employees of MVG own 11.7% of the company. The CEO’s share alone is currently worth more than EUR 2 m. I assume that for many employees their shareholdings in MVG represent a high proportion of their net worth. Hence, it should be in the full interest of management to increase the value of MVG’s equity.
I believe that this is a company with the potential to grow revenues organically at an annual rate of 6% to 8% over the next five to ten years. The outlook for the industry is very encouraging given all the new devices coming to the market which require antenna measurement. From my perspective management is making the right decisions to make sure MVG keeps it advanced position in the industry. In addition, the increasing share of recurring revenues from installed systems speaks for MVG’s business model.
The current uncertainty with regard to a potential takeover candidate and potential sales pressure coming from a large shareholder provide an opportunity to invest at what I believe is a very modest valuation for this type of company.
In my last post, I announced that I will establish a 3% position for the portfolio with a limit of EUR 10.5 per share under the assumption that I trade one third of daily volume at the VWAP. Due to the relatively low trading volume, I was so far only able to accumulate a 0.8% position at a VWAP o EUR 9.79.
The content contained on this site represents only the opinions of its author(s). I may hold a position in securities mentioned on this site. In no way should anything on this website be considered investment advice and should never be relied on in making an investment decision. As always please do your own research!