James Faulkner’s small cap of the week is Software Radio Technology

Software Radio Technology (SRT) has long been a favourite among hopeful private investors, but thus far it hasn’t been smooth sailing. Although demand for its products seems to be on an upward slope, the timing of revenues has been notoriously hard to predict. Perhaps understandably, house broker WH Ireland suspended its recommendation for the stock as of January 2014. However, after speaking yesterday with CEO Simon Tucker, I was left with no doubt that SRT’s tailwind was as strong as ever.

Software Radio Technology (SRT) is a world leader in the provision of advanced wireless digital technology solutions for the marine sector, specialising in identification, safety and tracking. SRT’s     products utilise over 20 years of R&D into radio-based wireless technologies, and its established distribution network gives it access to all the key international markets. In particular, the firm is a global market leader in the supply of AIS (Automatic Identification Systems) systems.

AIS is a kind of electronic licence plate for boats, which helps prevent collisions but also provides authorities with a log of the location and movement of vessels in international shipping waters, thus yielding benefits many benefits including improved safety and crime prevention. This is helping to persuade the authorities to legislate in favour of AIS, and several local mandates are expected to come into force over the coming years in the Middle East, South and Central America, the USA and Canada.

(As a novel illustration of SRT technology in action, log on to http://www.marinetraffic.com/ and zoom-in to a shipping region. More or less every one of the triangular shapes is a vessel using SRT technology).

AIS S100 Antenna Splitter

The total market for AIS could be worth up to $4 billion at retail value over the next decade, based on an estimate of 6.5 million vessels (25% of the 26 million in existence) with some requirement for AIS. In the short term, government mandates set to come into force in the next 3-5 years present a potential $450 million market opportunity made up of the Class A, Class B and Identifier products which represent SRT’s core market.

Aside from this core and well-underpinned market, there is also a significant blue-sky opportunity in next generation AtoN (Aids to Navigation) products which are mounted on buoys and other shipping hazards and integrate with the AIS network. Although early uptake is likely to be modest, the long-term upside is highlighted by the potential for an estimated 200k units each year which could be a $200 million per annum addressable market. The AtoN business was said to have made “meaningful progress” in H1.

What’s it worth?

With gross margins of c.50% and fixed overheads of c.£4.5 million, SRT is potentially a very profitable business. The manufacturing process is outsourced, so there is plenty of operational gearing waiting to kick-in should the promised upturn in demand arrive – and there is now more reason than ever to believe that that upturn could be on the horizon.

On 30th January 2015, the US Coast Guard formally published new regulations which require more commercial vessels in US waters to install and operate a USCG-certified AIS transceiver within the next thirteen months. The rules require that certain categories of commercial vessels, such as fishing boats, tugs, and ferries operating in US territorial waters install a USCG certified AIS transceiver. The first sign of an uptick from this quarter was seen on 22nd January, when the firm announced $1.1 million of orders for a range of its AIS OEM products from customers wishing to ensure that they have some stock to meet initial demand.

With the long-awaited US mandate now in the bag, I reckon SRT could begin to surprise on the upside. Breakeven looks to be around £10 million in revenues (i.e. £5 million in gross profit minus fixed costs of c.£4.5 million). If the promised uptick in activity materialises, the shares could fly.