DragonWave Update

Results
As noted in the original write-up the major risk for DRWI is its current dependence on 1 customer (Clearwire, 80%+ of revenues) and its need to increase its customer base.  As such, until it has a broader customer base, the potential for DRWI to be volatile, especially around earnings, is very high.  This is what we have seen over the last week around Q1-11 earnings. 

- The earnings numbers were adequate ($48mn revenue, $9.7mn profit, $0.27 EPS)
- However Q2 guidance spooked the market; with Clearwire only expected to contribute $6.25mn (vs. $38mn in Q1) and other customers expected to contribute $18.8mn (vs. $10.7 in Q1) to revenues.  The Clearwire drop being larger than the market expected, while other customers is growing quicker than the market expected.   
- This obviously leads to questions:
While a drop in Clearwire sales was expected (they are approaching the end of phase I of their 4G rollout), is the Clearwire drop a one-off (inventory digestion), a result of competition, or what?
Is the increase in other customers a one-off, one big customer, lots of little ones, etc?

Other Information
Here’s some of the other information that I’ve gathered (from reading the release and presentation, listening to the conference call, digging around a bit, etc)
- DRWI was surprised by CLWR’s Q2 demand, but the guidance is conservative so a new surprise is unlikely.  They’ve shipped 90-95% of the equipment for Phase I of CLWR’s buildout (where competitors won <10% market share), and Q2 represents c1/3 of what’s left.
- CLWR has been silent (so far) on the details of the Phase II rollout (150mn households vs. 120mn in phase I) though given they’ve not been shy of touting the speed of their 4G network, amongst other things, all indications are that it’s almost certainly going to go ahead.  Based on my assumptions on market share, number of towers involved, etc, this would represent c$175-200mn for DRWI spread over a number of quarters.
- Other Customers: Plans have accelerated and DRWI claims the pipeline is stronger than at any point historically.  It also should be noted that the Q2 revenue projection would be the highest non-CLWR quarterly revenue.
- OEMs: DRWI indicated it expects to sign a deal with a 2nd OEM in the next quarter.  DRWI aren’t giving much more details, except it’s a Tier-1 player and they’re expecting the demand to help in LatAm/Asia (good as only 17 of 88 customers, and <$0.5mn of revenue, are from those regions) and it’s likely to represent 10% of revenue within 1 year.

Other Thoughts
- Balance Sheet Value:  After Q1-11, DRWI has $3.15.share of Cash/ST Investments, a $3.49/share liquidation value and a Book Value of c$4/share.   In short, while the business is clearly risky, will be volatile and my thesis remains based on potential growth, you’re not paying a lot for the growth given the company is currently break-even (in Q2)/profitable (historically, and with any increase from Q2 revenues) and the  value of the balance sheet supporting it.
- Management:  The sense that I get is that they believe this is a soft patch, a gap between the first CLWR roll-out ending and new customers buying in size/CLWR Phase II kicking in.  However, from my conversations, they seem to be willing to cut costs appropriately should the soft patch be more prolonged. 
- Final Thought:  Given all the information, and the positive long-term thesis coupled with the balance sheet value, I’m comfortable with the DRWI position.  The major question that’s unresolved is how large this soft patch between CLWR Phase I and the take-up by new clients (and/or CLWR Phase II) is.  Should that extend into the 2nd half of the year, there may be the chance to pick-up some DRWI at close to its liquidation value (i.e. really get the business for free) but if it ends sooner, then yesterday’s $4.60’s prices will be the best we’ll see.  At this point, I’m comfortable with the current size of the position (1.4%), though could be looking to add to it if we see any prints in the $4 or below range.