Vislink. Conditional sale of hardware division. Industry evolution affected VCS performance. Group expected to return to profitability in FY17

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1 Vislink Conditional sale of hardware division Conditional disposal and Interims Tech hardware & equipment Vislink has announced that it has entered into a conditional agreement to sell the assets of Vislink Communication Systems (VCS) for $16m. The transaction is expected to be subject to shareholder approval and to close by end FY16. The deal frees management to focus on the software division, which reported a strong increase in order intake during H116, in contrast to the hardware division where H116 revenues fell by 19%, taking the division and the group into the red. The deal also solves the debt problem, leaving the group substantially debt-free. Net debt had reached 8.8m at end June and in September the group was fully utilising its 15.0m revolving credit facility, potentially breaching bank covenants. 28 October 2016 Price 14.38p Market cap 18m Net debt ( m) at end June 2016 (Prior to receipt of $16m consideration for VCS) 8.8 Shares in issue 124.6m Free float 90.3% Code VLK Year end Revenue ( m) PBT* ( m) EPS* (p) DPS (p) P/E (x) Yield (%) 12/ / /16e 46.9 (1.2) (1.6) 0.0 N/A /17e** Note: *PBT and EPS are normalised, excluding amortisation of acquired intangibles, exceptional items and share-based payments. **Includes VCS as disposal not yet approved. Primary exchange Secondary exchange Share price performance AIM N/A Industry evolution affected VCS performance VCS revenues declined by 19% year-on-year because of several factors specific to this division, taking VCS into a loss. H116 PBS revenues were very slightly lower than H115 because of delays to orders being received, although a 53% year-onyear improvement in order intake and the receipt of several significant new orders in September indicate a stronger H2. PBS operating profit reduced by 35%, reflecting investment in development and sales activities to support future growth. Group revenues dropped by 15% to 22.6m. The group shifted from 2.2m adjusted operating profit in H115 to 1.1m adjusted operating loss in H116. Exceptional costs totalling 29.7m relate to inventory, goodwill and IP write-downs associated with a complete restructuring of VCS to align its product offer with the changing industry environment. Group expected to return to profitability in FY17 We have cut our estimates again and now expect the group as a whole to be lossmaking in FY16. If the VCS disposal goes ahead, we estimate that profits from the PBS software business will be sufficient to return the group to profitability in FY17. If the disposal does not complete, we expect that the restructuring programme will return the division to a modest profit in FY17. Management is withdrawing the dividend until debt is less than 1x EBITDA. The potential VCS disposal is expected to leave the group substantially debt-free, enabling dividend reinstatement. Valuation: VCS disposal priced in Our analysis of the share price multiples of listed peers indicates that the VCS disposal is already priced in, with potential for share re-rating once the disposal has completed and assuming that the recent spate of software orders translates into divisional revenue growth. % 1m 3m 12m Abs (16.1) (14.8) (64.7) Rel (local) (17.8) (17.5) (67.5) 52-week high/low 40.5p 7.6p Business description Vislink is a global technology business specialising in the collection and delivery of high-quality video and associated data from the field to the point of usage. These are used in the broadcast, surveillance and public safety markets. Next events Prelims March 2017 Analysts Anne Margaret Crow +44 (0) Dan Ridsdale +44 (0) tech@edisongroup.com Edison profile page Vislink is a research client of Edison Investment Research Limited

2 Divisional review PBS software division to drive growth Order book underpins FY16 growth despite slower than expected first half At 5.4m, H116 PBS software division revenues were very slightly (1%) lower than H115 because of lower than expected revenue in Q216 arising from delays to orders. Divisional operating profit reduced by 0.6m (35% y-o-y), reflecting investment in development and sales activities to support future growth. Order intake rose by 1.9m (53%) to 5.4m. This was followed by news of several significant new orders at the IBC show in September, supporting management s and our expectations of a stronger second half and modest (7%) revenue growth for FY16 and FY17. We leave these divisional estimates unchanged. Long-term industry trends support growth PBS s positive order book is a reflection of supportive industry trends. PBS is in a different sector of the broadcast market to VCS. Unlike VCS, PBS is actually benefiting from the cost pressures on the global broadcast industry as these are causing the broadcast distribution paradigm to shift from processing content using dedicated hardware to processing content using specialist software hosted on standard hardware located either at the broadcaster s premises or in the cloud. Demand for PBS s products is therefore growing. Broadcasters are under pressure to launch new channels that will potentially attract niche advertising budgets. These cannot be launched without playout software, so PBS products can therefore be regarded as mandatory in nature. Moreover, PBS is a relative newcomer on the global stage with plenty of scope for gaining sales through partnering with Harmonic, a major North American supplier of broadcast distribution hardware. Relative growth prospects for divisions shape management strategy At the full year results presentation in March, management stated that PBS, though substantially smaller than VCS, was the growth engine for the group and where investment would be prioritised. The proposed disposal of VCS or the alternative radical restructuring of the VCS division (see below) accelerates this transition. VCS to be sold or radically restructured Issues specific to VCS result in divisional operating loss VCS division revenues fell by 4.0m (18%) year-on-year to 17.2m. This resulted in a 2.7m reduction in profits to an adjusted operating loss of 0.8m. Discussion with management suggests that the main reasons why VCS H116 revenues were lower than expected were specific to that division. Some new products were launched later than expected. There were delays in deliveries of some of the older satellite communications products because of issues with a supplier that have now been resolved. Demand from the surveillance sector, which remains key but has always been volatile because of the large scale of some of the projects worked on, was weak ( 2.0m in H116 vs 4.3m in H115). Finally, some potential customers delayed making purchasing decisions while they determined their strategy for migrating to HDTV (high-definition TV) and IP transmission. Long-term industry trends put focus on newer technologies While some of these issues have been fixed, the market environment for broadcast contribution businesses such as VCS continues to be difficult. During H116 broadcast order intake fell by 8.0m (36%) year-on-year. Broadcasters are experiencing severe pressures on costs because of the Vislink 28 October

3 movement of advertising expenditure from TV to online formats. While VCS products such as miniaturised camera transmitters help broadcasters create compelling content that will attract larger audiences and advertising income, they are essentially discretionary in nature, so sales are vulnerable in a downturn. Management estimates that the broadcast hardware market shrank by 10-15% during FY15. Equipment that helps broadcasters cut costs is doing better. Where possible, established broadcasters are shifting content transmission from traditional microwave and satellite links to IP-based networks. VCS has introduced several ranges of products to address this trend, although these took longer to bring to market than management had expected. For example Vislinknewsnet is an innovative IP-based system designed specifically for electronic news gathering. It enables reporters to edit material in the field as though they were in the studio, and producers to take content from multiple points of view without lengthy link set-up, thus delivering more high-quality outside content. Vislink ViewBack returns video from the studio to the field, enabling camera operators to see studio output and perfect their shots accordingly. The SatWare IP-based computing platform extends studio workflows to the field, enabling reporters across the globe to share files and video content. Restructuring activity to return VCS to profitability if retained In response to the structural changes in the market, management has begun to implement a farreaching restructuring programme of the hardware division with the intention of making it profitable and cash generative again. This involves more than simply cutting costs (which will affect H216 rather than H116). It is about taking a hard look at the product portfolio, prioritising investment on the equipment needed as the broadcast contribution industry transitions to IP-based transmission, making sure that VCS retains its market-leading position, and culling legacy technology. The first phase of this restructuring programme resulted in significant exceptional non-cash charges being recognised in the H116 results, as discussed below. The programme is expected to return the division to modest profitability in FY17, should the proposed disposal not go ahead. Conditional disposal of VCS At the interims, management announced a portfolio of measures (see below) to improve the cash position. This included potential disposals. Noting the structural shifts in the global broadcast industry, which favour software rather than hardware, management s stated strategy has been to build up the software division, while realigning the VCS division to meet the requirements of a rapidly changing market. Given this stated focus on software, VCS was the logical candidate for disposal. On 20 October, management announced that it had entered into a conditional agreement with xg Technology, a provider of private mobile broadband wireless networks, to sell the VCS assets for $16m. The transaction is likely to be subject to shareholder approval and to complete by end FY16. Importantly, the group will be substantially debt-free on completion of the transaction. Management changes On 13 th October, Finance Director Ian Davies resigned from the Board. Group financials Shortfall in H116 performance flagged in July trading update The weak performance in VCS resulted in a 4.0m (15%) year-on-year fall in group revenues to 22.6m. Gross margin declined by 6.8pp, reflecting pricing pressure and product mix in the VCS division. R&D costs increased by 0.8m (30%), as investment was made in both divisions to keep up with the evolving broadcast landscape. This rise was balanced by a 1.2m (28%) reduction in Vislink 28 October

4 administrative costs resulting from the restructuring activity in FY15. The group shifted from 2.2m adjusted operating profit in H115 to 1.1m adjusted operating loss (after deducting share-based payments of 0.3m in both periods). Refocused VCS activity generated non-cash write-downs In July, management noted that it intended to thoroughly review the VCS product portfolio. This resulted in a 23.3m reduction in the carrying value of VCS goodwill (now zero) and acquired intangibles, 5.5m VCS inventory write-down and 0.8m write-down of capitalised VCS inventory. (A similar calculation was performed on the PBS goodwill and no impairment was required.) Redundancy and restructuring costs were minimal ( 0.1m) during H116 as the restructuring was not announced until early July. The scope of the restructuring depends on how trading progresses during H2. We estimate 0.6m costs associated with restructuring during H216. Rising debt triggers breach of covenants, though bank remains supportive The shift from a positive to a negative operating result had a deleterious impact on net debt, which increased from 5.7m at end December 2015 to 8.8m at end June At the end of September the group s rolling credit facility of 15.0m was fully utilised. Management noted that the group was forecast to breach its banking covenant at end September, but remained in constructive discussions with its bankers. Management has proposed a portfolio of measures in addition to the ongoing VCS restructuring to improve cash generation: suspension of the dividend until bank debt is below 1x EBITDA; voluntary cancellation of VCP scheme; relocation of VCS finance function to head office to improve cash collection; and evaluation of other sources of finance or disposal opportunities. Exhibit 1: Changes to estimates Estimates revision FY15 FY16e FY17e Actual Old New % change Old New % change VCS revenues ( m) VCS EBITA ( m) (2.3) N/A PBS revenues ( m) PBS EBITA ( m) Group revenues ( m) Group adjusted PBT before deducting share-based payments ( m)** (1.2) N/A Share-based payments ( m) 0.0 (0.6) (0.6) 0.0 (0.6) (0.6) 0.0 Group adjusted PBT - after deducting share-based payments ( m) (1.8) N/A Adjusted EPS before deducting share-based payments (p) (1.6) N/A DPS (p) N/A N/A Net debt ( m) Source: Vislink accounts, Edison Investment Research. Note: **This is Edison s normalised PBT. Given that the VCS disposal is subject to shareholder approval, we have revised our estimates on the basis that the VCS division is an ongoing business. We will adjust our estimates to show the impact of the disposal once the disposal is confirmed. We provide a top-level view of the group s potential performance without VCS in the valuation section. The key changes we have made to our estimates are: Further reduction in VCS revenues to reflect continued weakness during Q3. Increase in central costs. We had reduced these in July as management expected the Brexitinduced fall in sterling against the dollar to result in a significant forex translation benefit during FY16 that would be netted against central costs. Noting that during H m favourable Vislink 28 October

5 movement on foreign exchange was credited to reserves rather than being netted against central costs, we have reversed this adjustment. Withdrawal of the dividend in FY16 and FY17 to conserve cash. Inclusion of 30.3m exceptional costs for FY16 relating to IP and inventory write-downs and one-off restructuring costs, (previously estimated at 8.0m). Group expected to return to profit in FY17 The combination of these changes results in a 19% year-on-year reduction in group sales to 46.9m during FY16, despite the 10% PBS revenue growth. This generates 1.2m loss before tax (adjusted for goodwill amortisation, share based payments and exceptional items). If the proposed VCS disposal does not go ahead, we expect group revenues to reduce by a further 2% to 46.1m in FY17 as PBS sales rise by 7% but the VCS product portfolio is reduced to focus on new technologies. A mixture of margin improvement from the focus on newer technology products and the impact of the cost reduction programme is expected to return VCS to modest ( 0.5m) profitability for FY17, enabling the group as a whole to return to pre-tax profitability. Assuming that the VCS disposal goes ahead, our analysis (Exhibit 2) indicates that the group will be profitable during FY17 in this scenario as well. High gearing of balance sheet potentially resolved by VCS sale Since management is consciously not cutting back on R&D to secure future profit growth and paid the FY15 dividend in July 2016, we expect net debt to increase to 10.5m at end FY16. This is equivalent to 73% gearing following the significant impairment of intangibles and write-down of inventory that affected net assets at end H116. This debt would be substantially eliminated by the receipt of $16m (c 13m) for VCS. Valuation: VCS disposal priced in The stock, which had been underperforming since the July trading update, picked up on the announcement of the proposed VCS disposal as this gives a route to resolving the potential breach of bank covenants. Since the disposal remains conditional, our estimates model VCS being retained in the group, but we believe it is helpful for valuation purposes to model the group s performance with VCS stripped out. Exhibit 2: Pro forma estimates excluding VCS FY16e including VCS FY16e excluding VCS FY17e including VCS FY17e excluding VCS Group revenues ( m) Group EBITDA ( m) Group PBT* ( m) (1.2) Group EPS* (p) (1.6) Source: Edison Investment Research. Note: *Before deducting amortisation of acquired intangibles, exceptional items and share-based payments. If we compare the share price multiples for the revenue, EBITDA and EPS estimates associated with a group comprised only of the software division (Exhibit 3), Vislink s prospective EV/Sales and P/E multiples are in line with the sector mean. We note that on an EBITDA basis Vislink appears to be trading at a discount to the mean, but this may be caused by variations in defining EBITDA. This suggests that the VCS disposal is probably already priced in, although there is potential for share re-rating once the disposal has completed and the recent spate of PBS orders has translated into divisional revenue growth. We will revisit our valuation once the VCS disposal is approved. Vislink 28 October

6 Exhibit 3: Multiples for listed peers Company Market cap Current EV/S Next EV/S Current EV/ Next EV/ Current P/E Next P/E EBITDA EBITDA Avid Technology Inc 233m 0.7x 0.7x 3.0x 3.6x 3.3x 4.5x Cobham PLC 2,803m 2.0x 2.0x 11.1x 10.3x 13.1x 12.9x Comtech Telecommunications Corp 205m 0.7x 0.7x 6.6x 5.8x 26.5x 29.9x Evertz Technologies Ltd 754m 2.8x 2.6x 10.0x 8.9x 16.3x 14.9x EVS Broadcast Equipment SA 416m 3.5x 3.7x 9.6x 11.4x 14.7x 17.6x GoPro Inc 1,138m 0.7x 0.5x x - - Harmonic Inc 337m 0.9x 0.8x 9.3x 3.7x 123.7x 15.2x Harris Corp 9,009m 2.1x 2.0x 9.6x 9.0x 15.5x 14.2x PC-Tel Inc 76m 0.6x 0.6x 8.0x 6.4x 22.5x 16.1x Sepura PLC 51m 1.1x 1.0x 16.8x 8.1x 1.1x 5.2x ViaSat Inc 2,896m 2.9x 2.7x 12.8x 11.9x 58.3x 62.3x Vitec Group PLC/ 272m 1.0x 1.0x 6.2x 5.9x 11.1x 10.3x Mean 1.6x 1.5x 8.6x 7.7x 15.5x 14.5x Vislink at 15p/share (debt end FY16e) 19m 0.6x 0.6x 10.1x 4.7x N/A 11.5x with VCS FY16 and FY17 Vislink at 15p/share (debt end FY16e) without VCS FY16 and FY17 19m 1.4x 1.3x 3.4x 3.1x 16.7x 12.5x Source: Bloomberg, Edison Investment Research. Note: Prices at 17 October 2016 Grey shading indicates exclusion from mean. Vislink 28 October

7 Exhibit 4: Financial summary m e 2017e Year end 31 December IFRS IFRS IFRS IFRS PROFIT & LOSS Revenue Cost of Sales (33.5) (31.8) (26.0) (22.8) Gross Profit EBITDA Operating Profit (before amort and except) (0.8) 2.4 Amortisation of acquired intangibles (2.6) (2.4) (1.4) (0.3) Exceptionals 0.9 (3.1) (30.3) 0.0 Share based payments (0.5) 0.0 (0.6) (0.6) Operating Profit 5.5 (0.8) (33.0) 1.5 Net Interest (0.1) (0.2) (0.4) (0.4) Profit Before Tax (norm) (1.2) 2.0 Profit Before Tax (FRS 3) 5.4 (1.0) (33.4) 1.1 Reported Tax (1.6) 0.1 (1.0) (0.4) Profit After Tax (norm) (2.0) 1.6 Profit after tax (FRS 3) 3.7 (0.9) (34.5) 0.7 Average Number of Shares Outstanding (m)* EPS - normalised (p) (1.6) 1.3 EPS - normalised fully diluted (p) (1.6) 1.3 EPS - (IFRS) (p) 3.2 (0.7) (28.2) 0.6 Dividend per share (p) Gross Margin (%) EBITDA Margin (%) Operating Margin (before GW and except) (%) N/A 5.2 BALANCE SHEET Fixed Assets Intangible Assets Tangible Assets Deferred tax assets Current Assets Stocks Debtors Cash Current tax assets Current Liabilities (22.4) (23.1) (26.4) (25.4) Creditors (16.8) (14.1) (14.4) (13.4) Short term borrowings (5.6) (9.0) (12.0) (12.0) Long Term Liabilities (8.0) (6.1) (5.6) (5.6) Long term borrowings (2.4) Other long term liabilities (5.6) (6.1) (5.6) (5.6) Net Assets CASH FLOW Operating Cash Flow Net Interest (0.1) (0.2) (0.4) (0.4) Tax (0.1) (0.9) (0.5) 0.1 Capex (4.6) (3.8) (4.5) (4.5) Acquisitions/disposals (7.0) Financing 2.0 (0.0) Dividends (1.5) (1.8) (1.8) 0.0 Forex (0.0) Net Cash Flow (3.3) (6.1) (4.8) 1.0 Opening net debt/(cash) (3.7) (0.4) HP finance leases initiated Other Closing net debt/(cash) (0.4) Source: Vislink accounts, Edison Investment Research. Note: *Excluding shares held in Employee Benefit Scheme. Vislink 28 October

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