Avigilon IPO Plan Analyzed

Megapixel surveillance manufacturer Avigilon announced plans to IPO [link no longer available]. This is a major and rare move for video surveillance companies, riding on the explosive revenue growth of Avigilon for the past few years. In this note, we examine the details and the potential impact of Avigilon's IP0. Update: We examine potential concerns and strategic issues from reviewing their detailed financial reports.

Let's start with a review of key data points from Avigilon's preliminary IPO prospectus:

• 2010 revenue was $32 Million CAD
• 2011 revenue for first 6 months was $26 Million CAD, up 88% year over year and putting them on track for nearly $60 Million CAD revenue for 2011
• International revenue has been exploding, tripling between 2009 and 2010 from ~$4 Million to ~$12 Million
• The company has 129 employees total with 49 in manufacturing, 25 in sales, 26 in R&D

With the proceeds of the IPO, the company intends to significantly expand product development (hiring 30-40 people in the next 2 years) and expand sales offices in Brazil, China, India, Eastern Europe and South Africa.

Avigilon has not yet disclosed how much it is looking to raise nor the target valuation.

Below is a graph of revenue growth showing how fast it has been. Note it does not include 2011 where Avigilon's near 100% growth rate has continued:

The continued growth rate, especially in 2011, and the approaching of $60 Million in annual revenue is quite impressive. While still below companies like Mobotix (~$100 Million), they are catching up to Genetec, Milestone, Arecont Vision, IndigoVision who had a huge head start on Avigilon.

Concerns

On the negative side, a number of Avigilon's detailed financial metrics point to potential concerns. These are specifically:

• Low Gross Margins: Avigilon's gross margins are only in the 42-44% range. This is notably lower than Axis (50-51%)and significantly lower than Mobotix (~70%).
• Low Net Margins: Avigilon's net margins are in the low single digits. By contrast, most IP camera manufacturers are in the 10%-20% range.
• Low and Flat R&D Expenditures: Avigilon is spending about $2 - $2.5 Million CAD on R&D with almost no increase year over year. For a company that will generate over $50 Million in revenue this year, only about 5% of revenue will go to R&D. More typically with competitors this is over 10%.

Of these three metrics, the one that raises the greatest concern/interest is the low gross margins. Low gross margins generally mean one of two things: (1) the company has a difficult time selling so it needs to drop price to get buyers or (2) the company has explicitly decided to set agressive price points to gain market share. Avigilon obviously has no problem increasing sales and their prices are very attractive (people regularly talk about how 'cheap' Avigilon's encoders and MP cameras are). Our suspicion is that Avigilon has set low prices and is accepting below market gross margins as a company strategy. [Note: Because of the IPO plan, Avigilon is in a dark period and cannot comment on this topic.]

So long as Avigilon can manage such fast growth, we think this is a promising strategy. As fast overall IP camera market growth is still likely for a number of years to come, giving up short term profits is likely a good tradeoff to establish long term greater dominance.

The second and final concern we have is the relative low spend on R&D. Over the last year, Avigilon's new product announcements have been relatively minor (especially compared to their growth rate). While the 29MP camera announcement generated buzz, it is an incremental update of a 4 year old product line - not a radical new innovation. We suspect, though are not certain, that the extremely fast growth has limited free cash flow. Once the company IPO occurs, we anticipate that the proceeds will be used to ramp up R&D expenditure (as stated in the prospectus) and new product development. This should be watched.