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Buy, Sell or Hold Bridgewater Systems (TSX:BWC) with Daniel Lee of M Partners

by Arjun Rudra

With the energy and financial sectors constituting over 50% of the S&P/TSX Composite, we seldom hear about new and emerging companies in the technology sector, lest they be related to Research in Motion (RIM:TSX). Given this apparent void, we are thrilled to present the following interview with equity research associate, Daniel Lee of M Partners and his take on a company by the name of Bridgewater Systems (TSX:BWC).

Daniel Lee is an Equity Research Associate covering the technology sector at M Partners

Daniel Lee is an Equity Research Associate covering the technology sector at M Partners

Biography: Daniel Lee is an Equity Research Associate covering the technology sector at M Partners. Before joining M Partners, Daniel worked at a private equity firm focused on emerging growth and distressed technology companies. Daniel has also worked for a leading corporate law firm where he toiled over various securities and M&A transactions. Prior to entering the “real world”, Daniel enjoyed the life of a professional student, obtaining a law degree and masters in financial economics from the University of Toronto and an undergraduate degree in economics and finance from York University. Deciding that he missed studying, Daniel enrolled in the CFA program and is presently a level two candidate.

Over to you, Daniel …

[Note that some of the analysis provided is taken from a recent report published at M Partners]

Q: Since Bridgewater Systems (TSX:BWC) is a Canadian tech stock that you follow, why don’t you start off by telling us a little bit about what the company does?

A: Bridgewater Systems provides mobile broadband networks a range of policy-based network optimization solutions including subscriber policy management and data offloading from cellular to WiFi/WiMax femtocells networks.  Broadly speaking, policy management software helps network operators control data traffic by setting up rules that determine how, when and under which circumstances subscribers can access networks, applications, and services.  An example of a policy rule is the prioritization of traffic and allocation of bandwidth - if the network becomes congested, a rule to downgrade service to subscribers downloading music in order to guarantee timely delivery of time sensitive data (e.g. voice, online gaming) can go a long way to increase quality of service.  Bridgewater’s data offloading solutions, “offload” data traffic from congested mobile networks and onto to another access technology such as Wi-Fi, WiMax, or femtocells.

Q: Can you talk a bit about the vertical Bridgewater specializes in? How much is Bridgewater a “sector pick” as opposed to a pure bottom-up pick?

Bridgewater Systems

Bridgewater Systems (TSX:BWC) Price Chart

A: Bridgewater is one of our top picks at the moment from both a top-down and bottom up perspective. The burning problem in the market that Bridgewater’s solutions address is the data explosion on broadband wireless networks caused by the rapid adoption of smart phones. According to Cisco, smart phones like the iPhone and Android based phones consume up to 40x more data than typical feature phones. In real terms, ten million smart phone users consume as much data as 390 million feature phone users. One only has to look at the challenges faced by AT&T right now in terms of overall quality of service due to broad iPhone adoption. The big challenge for mobile operators is that while data traffic is expected to grow at 108% CAGR for the next five years, revenue is only expected to climb at only 10% CAGR over the same timeframe.

Data traffic is expected to grow at 108% CAGR for the next 5 years

The big challenge for mobile operators is that while data traffic is expected to grow at 108% CAGR for the next five years, revenue is only expected to climb at only 10% CAGR over the same timeframe.

Source: www.wirelesshabitat.eu

Bridgewater’s solutions can help network operators to reduce mobile data delivery costs by over 60% over the next three years. However, cost reduction is only one-side of the equation. Network operators are now creating new business models that move away from unsustainable “all you can eat” data plans, towards tiered and usage based pricing underpinned by policy management.

Q: What about valuation? How does Bridgewater’s valuation compare to its peers?

A: Valuation is what makes Bridgewater appealing from both a top-down and bottom-up perspective. From a fundamental perspective, the company has grown at a compounded quarterly rate of over 12% since it went public in December 2007. In addition, it has been profitable for the past eight consecutive quarters, recently reporting an EBITDA margin of over 26% for Q1/2010.

Bridgewater has been profitable for the past eight consecutive quarters

Bridgewater Systems has been profitable for the past eight consecutive quarters

Despite this impressive performance, the company trades at 7.1x FWD EV/EBITDA based on our 2010 forecasts compared to its peers which trade at an average of about 16.7x. Although a small discount may be warranted since its peers are a little bigger than Bridgewater, I don’t think a discount of 56% is fully justified given Bridgewater’s remarkable growth and profitability profile.

Valuation “]Bridgewater Systems TSX BWC Valuation

Bridgewater Systems [TSX:BWC

At M Partners, we have a target price on the company right now of $14.30 implying a potential ROI of just under 60% based on a May 10th closing price of $9.00/sh. Our approach to valuing Bridgewater was based on a multi-stage discounted cash flow (“DCF”) utilizing fairly conservative assumptions. I believe our DCF value is reasonable as it implies forward EV/EBITDA and P/E multiples of 15.9x and 29.8x respectively. Compared to peer averages, these multiples still represent a discount of 5.3% on a FWD EV/EBITDA basis and 24.3% on a FWD P/E basis.

Q: Can you describe Bridgewater’s competitive environment? How is the company positioned vis-a-vis its competitors?

A: Infonetics Research in its April 2010 report “Policy Servers Biannual Worldwide and Regional Market Size, Share, and Forecasts” ranked Bridgewater as the # 1 market share leader in policy management software. So I think it is safe to say the company is well positioned in its market.

Bridgewater competes with large equipment vendors such as Erikson and Juniper as well as a few small private companies. With the acquisitions of Blueslice and Camiant by Tekelec (NASDAQ: TKLC) this week, Bridgewater is now one of the few “pure-play” policy management vendors remaining. Although network equipment vendors have the potential advantage of being able to offer a bundled solutions, Bridgewater differentiates itself by offering solutions that are network agnostic and vendor neutral. This means that Bridgewater’s solutions enable rapid deployment onto multiple or converged networks while at the same time supporting different network equipment, policy enforcement products (e.g. DPI), applications, and OSS/BSS software.

Q: What catalysts do you see that could move Bridgewater’s stock price?

A: During the Q1’10 conference call, management indicated an RFP pipeline for the quarter that was 75% of all RFP activity in fiscal 2009. Management also provided revenue guidance of $85M to $95M for fiscal 2010 with contracted revenue and backlog representing 75% of guidance. Any large new Tier 1 contracts announced could impact the stock price significantly.

Also, Bridgewater could be a takeout target by large equipment vendors as well as enterprise software vendors looking to extend their reach into the telecom vertical. Valuation multiples paid for companies like Bridgewater range from 3x to 8x revenues implying a significant blue sky value. Applying the median transaction multiple of 4.9x trailing twelve months revenue implies a potential share price of $17.60.

Q: What are some of the risks associated with Bridgewater?

A: The biggest risk associated with Bridgewater is customer concentration. During Q1/2010, 85% of revenues came from Bridgewater’s top five customers. However, this risk is diminishing as the company rolls out additional solutions to more carriers over the next several quarters.

Bridgewater Systems is a leader in a very lucrative traffic/subscriber management niche. As a result, it is being attacked from below the technology stack from deep packet inspection (“DPI”) vendors and from above from OSS/BSS vendors. However, with the massive increase in data demand, there is a lot of room for competition, and it has built some barriers with a head start in network agnostic solutions. If anything, this would make BWC an attractive acquisition target as market growth accelerates.

Disclosure: Neither I, nor Daniel or Ron Shuttleworth own any BWC stock.

If you have any questions about the article/research report please direct them to Daniel at [dl (at) mpartners (dot) ca] or technology analyst Ron Shuttleworth at [rs (at) mpartners (dot) ca]

Thank you Daniel!

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