Adacel - Hated stock

Adacel (ADA) trades on a $50 million market capitalisation at less than 1 times revenue which is traditionally a very attractive buying multiple for a software company.  This compares with recent history where the stock market was quite happy assigning a 3 to 5 times revenue multiple.

Undoubtedly the company has disappointed the market with the loss of a significant FAA Support contract but surely the market is throwing the baby out with the bath water.  Revenues are expected to be broadly unchanged post the loss of the FAA support contract however the core system being supported by the third party whom won the support contract paradoxically remains Adacel's.  Adacel is part of the industry furniture in the simulation space.

This company is a significant player in its air traffic simulation and air traffic management systems market. It claims 90% market share in the US air traffic controller simulation systems market with 350 air traffic simulators (MaxSim) installed (67% of business).  The company layers training services around its MaxSim simulation software systems technology.

The other significant part of Adacel business is the Air Traffic management system called Aurora (circa 33% of business).  They describe this as a real-time, distributed, open architecture air traffic management automation system. Adacel focuses on the market niche of oceanic and non-radar based air traffic management, covering in excess of 41 Million Sq Miles of airspace across 9 segments globally.

The combined Adacel business generate circa 60% of their revenue from recurring revenue sources (maintenance, technical services, long term training contracts) and 40% from system sales.  The gross profit margins are significantly better in the recurring sources then the system sales with the latter increasingly priced on little gross profit margin in-order to get the higher margin recurring maintenance, technical services and training revenue in later years.

Bottom line in the 5 years to 30 June 2018, Adacel has generated an average net cashflow per year (post tax, capitalised research and development) of $5.3 million which suggests ADA trades on less than 10 times historical free cash generation or greater than 10% free cashflow yield.  The company has a strong business model with 60% recurring in nature. The services revenue has dropped in 1H 2019 by circa 10% from 2018 levels (loss of FAA support), but it’s nothing the company can't recover from.

Without having specific knowledge of this niche air traffic simulation and controller management systems industry the broad parameters of the business look good.  It’s a very opaque space however with tight security requirements over information with military and civil aviation clients, which is probably a drag on the ADA share market rating.  The broad investment thesis is Adacel will win and lose training contracts, but its core systems are still quite entrenched in the US military and civil aviation markets. I'm not saying the 2019 result will be strong but Adacel can recover in time and surely also remains an acquisition target for someone when trading at less than 1 times revenue.