Megaport Limited (“Megaport”) is a successful early mover in the Australian software space, with shares up 250% since inception in 2015. The company has since taken a hit falling 21% in the past year as investors reacted to renewed guidance estimates coming in below expectations.
Who is Megaport (ASX:MP1)? ★★★★
- Fair Value Estimate: $10.50 (-16% from previous analyst note)
- Share Price: $7.89 (as at 29/11/24)
- Moat Rating: None
- Uncertainty Rating: Very High
- Price to Fair Value: 0.75 (Undervalued)
The business operates as a Network as a Service (NaaS) provider. The company's global Software Defined Network (SDN) helps businesses connect their network to cloud services, data centres and other major infrastructure. Megaport currently has connections to 930+ DCs and over 2,600 customer logos.
The company recently reaffirmed guidance for fiscal 2025, which came in lower than our expectations, and guided for a similar growth trajectory in fiscal 2026. This is indicative of a significant overestimation of pricing power and competitive position.
Despite this, the firm has made strides in 2024, breaking through $200 million in Annual Recurring Revenue and posting its first ever net cash flow positive year, generating $28 million and delivering a full year of profitability after tax.
Why the downgrade?
Recent price hikes have left Megaport’s products in an uncompetitive position relative to market alternatives. The company’s current position leaves it with three choices: revert recent price hikes (lowering revenue whilst leaving a sour memory for its customers), splurge significantly more resources to sell its products at current prices or simply hope that competitors raise prices.
No moat in the horizon
Economic moats can be derived from sources such as scale, network effects, intangible assets, cost advantages and switching costs. Despite being a leader in an attractive, emerging industry, we do not believe there is enough evidence to warrant assigning Megaport a moat.
However, it is important to note that there are significant barriers to entry into Software Defined Networking (“SDN”). Aspiring new entrants would require presence in over 100 data centres and the ability to offer connectivity services to the largest handful of Cloud Service Providers to become competitive. This would require significant capital expenditure and several additional years to attract customers to increase utilization and attain operating leverage.
Moreover, new entrants would struggle to convert prospective clients, unless they pursued them at lower price points to Megaport and other more established SDNs.
Key risks
Given the Very High Morningstar Uncertainty Rating, the company lends itself to investors with a risk profile more tolerant of volatility. Intensifying competition on price and comparable offerings have quickly erodedMegaport’s early-mover advantage. The industry'semerging position currently limits competitive pressures;however, we expect eventual commoditizationand price-basedcompetition which may negatively affect operating margins.
Capital allocation woes
We assign Megaport a Poor Capital Allocation Rating due to poor investment efficacy. The company has invested heavily to achieve widespread network coverage and density, allowing it to gain sufficient scale and increase its share of customer demand, setting it up to achieve years of high growth. However, recent pricing miscalculations (signaled by lower-than-expected guidance) have risked reversing these benefits.
Is it still undervalued?
Driven primarily by its existing customer base; Morningstar assumes revenue will continue to grow at an organic compound annual growth rate of 10% over the next decade.
The balance sheet remains sound with a net cash position of $61 million at the end of fiscal year 2024. Investors can expect full-year net profit after tax profitability and positive free cash flows from fiscal 2024 onwards.
We reaffirm that Megaport continues to screen as undervalued with a price to fair value of 0.75, indicating a 25% discount at current prices. Our revised fair value estimate of $10.50 implies an 8x enterprise value/sales multiple with a weighted average cost of capital around 7.5%.