PCTEL May Have The Right Combination For The Next Leg

I'm perfectly happy recycling past investment ideas, and PCTEL (PCTI) treated me quite well indeed when I owned the stock about a decade ago. Since that time, though, the company has gone through a significant transformation and is really only the same in name only. Different isn't always better, but I do believe that PCTEL now operates a collection of businesses with interesting growth and margin potential. PCTEL does not appear to be tremendously undervalued today on a cash flow basis, but with almost $3 per share in cash on the balance sheet further acquisitions could improve its growth prospects further.

A New Era With Antennas And Test

Relative to when I last actually owned the shares, a lot has changed at PCTEL. The company has gotten out of the modem and mobility businesses and is now focused on antennas and wireless test. Both offer credible end-market revenue potential and an opportunity for PCTEL to stand out with proprietary products that can deliver solid margins and cash flows.

On the antennas side, PCTEL antennas can be used in a wide variety of applications from mobile radio to WiFi to GPS and machine-to-machine communication. PCTEL management defines the company's core addressable market as a 5% to 10% slice of a $30 billion market for process automation, smart grid, public safety, fleet management, and enterprise WLAN. Companies ranging from Harris (HRC) to Deere (DE) to Cisco (CSCO) have used PCTEL antennas, and Cisco incorporates the company's antennas into their higher-end wireless products.

While radios for emergency responders has been a sizable market for the company in the past, WiFi is likely to be a bigger part of the future, particularly as companies deploy equipment to improve indoor wireless coverage. Elsewhere, machine-to-machine communication and SCADA (supervisory control and data acquisition) continue to grow and the "internet of things" could lead to additional growth in the automation industry.

PCTEL's other major business is in test equ! ipment, particularly scanning receivers that are used to monitor, optimize, and diagnose problems in wireless networks. While this is a smaller market (by at least an order of magnitude), the company has carved out a good niche against rivals like Anritsu and JDSU (JDSU).

There is also an opportunity here for PCTEL to continue leveraging technology to expand market share and its revenue potential. One recent example is the introduction of a pay-per-use option for its SeeGull EXFlex product that allows carriers to acquire the equipment for next-to-nothing and pay only as they use it. The sometimes high cost of capex in the test market is part of what makes the industry so cyclical, and this could be an interesting way for PCTEL to accommodate the budget needs of its clients and establish a more predictable revenue and margin model.

Will This Be The Right Combination?

It's well worth noting that PCTEL has really gone nowhere fast for about eight years, though revenue has nearly doubled from the trough in 2009. Some of this could be tied to the challenges in carrier spending and wireless markets, but at least some of it has to also be attributed to the company's unsettled collections of business and operations over the better part of the last decade.

Perhaps now things have changed. The overall revenue opportunity in test (which the company reports as RF Solutions) is likely less than $200 million a year, but the $30 million or so in implied annual revenue on the basis of the last quarter suggests worthwhile growth potential, as do the 46% year on year growth rate and segment gross margins well in excess of the full company average. Better still, I would think the relatively modest size of the market PCTEL focuses on within test could serve to discourage rivals like JDSU, Anritsu, or Rohde & Schwarz from really targeting it with the same gusto as the company.

RF Solutions certainly has potential, but I think the bulk of the growth and margin improvements will have to be le! d by Conn! ected Solutions, and primarily the antenna business. I do believe the SCADA growth opportunity is real, and PCTEL could be looking at significant potential growth if leading automation companies like Siemens (SI) and Honeywell (HON) work PCTEL antennas into their process automation platforms. I likewise believe that WiFi and indoor wireless are real opportunities, though rivals like Laird (LARFF.PK) and CommScope could capture much of that for themselves.

All told, I'm looking for PCTEL to post long-term revenue growth of 9%, slightly higher than the trailing 10-year growth rate now that the company appears to have refocused around these two promising business lines.

Margins are the dicier part. PCTEL doesn't have a particularly good record of free cash flow generation, and both gross margin and operating margin have trended lower in recent years. Assuming that China Mobile (CHL) gets moving on its TD-LTE roll-out, high-margin scanner sales could help boost margins, but proving that the company can deliver consistent margin improvement is a significant "must do" on management's list. For now, I'm giving the company a large benefit of the doubt and projecting the sort of high single-digit/low double-digit free cash flow margins that others in the test and antenna/comm equipment sectors have managed in the past.

The Bottom Line

Those prior assumptions make PCTEL look as though it could be worth nearly $11 on a discounted cash flow basis. The company's price/book value and EV/sales ratios further suggest that either little attention is being paid to this stock (only two sell-side analysts follow it), or the Street simply doesn't believe in the growth/margin improvement story. I would note that nearly 25% of my estimated fair value is net cash, and that's a good news/bad news proposition (it could either be leveraged into value-added M&A or wasted on value-destroying M&A).

PCTEL is a thinly-traded micro-cap with a lot left to prove. That said, management's plan seems bo! th cogent! and reasonable, and I think this stock is worth further due diligence.

Source: PCTEL May Have The Right Combination For The Next Leg

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. (More...)