A play on software-based carrier networks

It’s a long story but carriers are shifting from using dedicated hardware boxes for network functions to software running on general purpose hardware. The trend has been in place since the debut of the internet and the http protocol. Networks are big and ugly though so they take time to change. When they are mission-critical it takes even longer.

To make a long story short we believe one small company, Radcom (Nasdaq:RDCM), has also shifted from a hardware to a software provider serving these carrier networks. Now Radcom is in a position to enjoy a new product cycle with their software-based network performance monitoring solution. Rather than repeat the essence of the story we’d encourage anyone interested to review their recent investor presentation(PDF) for the story. If there’s a short version it’s sort of “as virtualization did for storage and then systems it will do for the network.” Here is one picture that gets at the idea:

RDCM View of Shift

RDCM View of Shift

Our own checking suggests that the opportunity is real and comes to a question of timing. So it’s more about “when” versus “if” when it comes to adoption. The company has made progress in the past few quarters and is solidly profitable even before any major wave of new product revenues comes in. This helps limit the downside and increases our confidence that when additional software revenues come they will drop down to operating earnings (RDCM has a 72% gross margin.)

Turning to our “intrinsic valuation” or IV we see the shares at $20 versus the current $11 and change so the upside is material. It’s worth remembering that this market is fraught with “lumpiness” and a small group of powerful customers that tend to move slowly with shifting priorities. Given the cash on the balance sheet ($1.15/share) and current profitability this is probably more of a “dead money” risk if they don’t land additional large customers in the next 12 months. It’s been written elsewhere that they are an attractive M&A target. For reference: Is Radcom Manuevering to Sell Itself? on Seeking Alpha.

Our IV model is below. Risk management = investment success.

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