The S&/ASX 200 technology sector has fallen 20% in the past month, with investors re-evaluating the sector’s lofty return and earnings expectations. We take this opportunity to evaluate long-term returns across our Australian tech coverage through the lens of a company’s reinvestment runway.

Why it matters: We see a long reinvestment runway as a strong indicator of durable, above-average revenue growth, which is the key driver of long-term shareholder returns. Across our mature tech coverage, around two-thirds of share price returns over the past decade were from revenue growth.

  • We assess a company’s runway by evaluating the scope for profitable reinvestments in sales and marketing, and research and development. High returns on these types of investments imply a long runway, and vice versa.
  • We believe the market is generally overly focused on the short term and assumes that growth will mean-revert. As a result, it structurally underappreciates companies with long reinvestment runways.

The bottom line: We believe narrow-moat Audinate (ASX: AD8) has a long reinvestment runway in sales and marketing, as well as research and development. Unsurprisingly, given the size of the runway, shares are materially undervalued versus our fair value estimate of $15 per share.

  • Audinate’s runway is supported by its dominant position in digital audio networking, with its Dante protocol working with 14 times the number of products of its closest competitor. We expect the difference in the number of devices deployed in the field to grow even larger.
  • Like other network effects, increasing penetration makes it easier and cheaper to attract even more customers. With original equipment manufacturers increasingly catering to networks that AV professionals are used to working with, which means Dante, we expect a 10-year revenue compounded annual growth rate (“CAGR”) of 17%, well above consensus.

Forecast of deepening losses has made us revisit our thesis for Audinate

We expect Audinate’s strategy to primarily focus on accelerating the secular transition toward digital audio networking. Secondarily, we expect Audinate to focus on building out its nascent business for digital video networking.

Audinate’s Dante protocol has become the world’s most widely used protocol for digital audio networking and boasts a more-than 14 times lead over its nearest competitor, Ravenna, in terms of the number of products enabled with the protocol. Given Dante’s dominant market share, we see little remaining upside for Audinate from gaining incremental market share from direct competitors in digital audio networking. However, we do expect Audinate to use its network effect, its existing customer relationships, and its scale on research and development to accelerate the AV industry’s transition toward digital audio networking.

Specifically, we expect Audinate to continue creating new hardware and software solutions that unlock new device use cases and to continue developing new software solutions for AV professionals. We estimate Audinate has around 10% market share in audio devices, which leaves Audinate with a large and highly winnable market opportunity, as the industry digitizes. Additionally, we expect Audinate to gain significant pricing power, especially in its software segment, as its network effects continue to strengthen.

We also expect Audinate to continue developing its nascent digital video networking business, although we view this as a more uncertain and likely less profitable opportunity. Video networking has unique challenges compared with audio, primarily due to the larger data intensity inherent in video data delivery. Because of this, digitally networked video uses various compression technologies that are usually not compatible with each other and therefore hinders the establishment of network effects. However, we believe network effects from Dante’s audio solutions will help pull in AV professionals, who are already familiar with the Dante protocol, which in turn pulls in original equipment manufacturers, or OEMs.

Bulls say

  • Audinate is the world’s most widely used protocol for digital audio networking and boasts a more-than 10 times lead over its nearest competitor. Audinate’s leadership position in audio is supported by network effects.
  • Audinate has a large and highly winnable market opportunity, as it helps digitize the AV industry, which is still in the early stages of digitizing.
  • Audinate’s entry into digital networking for video is showing exceptional growth and promise and may provide a second leg of growth comparable in size to audio

Bears say

  • The AV industry is still in the early stages of digitizing, meaning there is high uncertainty as to how large the market opportunity will ultimately be.
  • Audinate has only recently entered the digital networking market for video and may face significant established competition.
  • Audinate’s end markets are highly cyclical.

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Terms used in this article

Star Rating: Our one- to five-star ratings are guideposts to a broad audience and individuals must consider their own specific investment goals, risk tolerance, and several other factors. A five-star rating means our analysts think the current market price likely represents an excessively pessimistic outlook and that beyond fair risk-adjusted returns are likely over a long timeframe. A one-star rating means our analysts think the market is pricing in an excessively optimistic outlook, limiting upside potential and leaving the investor exposed to capital loss.

Fair Value: Morningstar’s Fair Value estimate results from a detailed projection of a company’s future cash flows, resulting from our analysts’ independent primary research. Price To Fair Value measures the current market price against estimated Fair Value. If a company’s stock trades at $100 and our analysts believe it is worth $200, the price to fair value ratio would be 0.5. A Price to Fair Value over 1 suggests the share is overvalued.

Moat Rating: An economic moat is a structural feature that allows a firm to sustain excess profits over a long period. Companies with a narrow moat are those we believe are more likely than not to sustain excess returns for at least a decade. For wide-moat companies, we have high confidence that excess returns will persist for 10 years and are likely to persist at least 20 years. To learn about finding different sources of moat, read this article by Mark LaMonica.