MIAMI BEACH, Fla.--(BUSINESS WIRE)--Windward Management LP today issued the following open letter to the board of directors of NETGEAR Inc.
May 24, 2024
NETGEAR, Inc.
Attn: The Board of Directors
350 E. Plumeria Drive
San Jose, CA 95134
Members of the Board of Directors,
Windward Management LP (collectively with its affiliates, “Windward”, “we”, “our” or “us”) controls ~4.2% of the outstanding common shares of NETGEAR Inc. (NASDAQ: NTGR) (“NETGEAR” or the “Company”). Windward, and its CIO Marc Chalfin, has a record of suggesting accretive and value enhancing measures to both management teams and boards, and we are highly dedicated to creating and augmenting value for all shareholders, including our clients.
We appreciate the Company and the Board’s efforts to navigate a multitude of headwinds coming out of COVID, including substantial supply chain disruption and working down significantly bloated inventories from a COVID-driven “hangover”; only further amplified by massive multi-quarter channel destocking, and an increasingly challenged macroeconomic environment. If that were not enough, this litany of headwinds was only further exacerbated by some misguided operational decisions under the prior CEO/Founder, and thus far we are aligned with several of the operational business decisions under the new CEO CJ Prober to reverse some of the damage shareholders have recently suffered through. Namely, pulling forward destocking to align sell-in with sell-through ahead of the imminent WiFi 7 upgrade cycle and going back to a “good, better, best” approach to recapture lost shelf space, both we believe are smart decisions. However, we strongly believe that the cash position of the business in the context of the Company’s current valuation necessitates swift and decisive actions on the capital allocation front:
1. As of the end of Q1 2024, NETGEAR has over $289mm of cash and short-term investments on its balance sheet vs. a current market capitalization of ~$370mm. The company has guided to generating meaningful free cash flow for the remainder of the year, rendering the pro forma year-end enterprise value as being potentially less than zero. On the Company’s last earnings call, management indicated they expect to generate free cash flow of $8mm-$15mm in Q2 2024 (despite ripping the band-aid on significant channel destocking/-EBITDA) and will generate material free cash flow in the back half, as a result of inventory turns normalizing to ~4x from ~2x currently. While the trajectory of 2H 2024 EBITDA remains unclear, conservatively assuming breakeven EBITDA in 2H implies the Company’s year-end net cash balance will be ~$350mm. We would argue there is more risk to the upside, as our estimates assume EBITDA is $10mm lower YoY in 2H, despite lapping trough inventory levels and with tailwinds from the WiFi 7 upgrade cycle (last upgrade cycle drove double-digit unit growth augmented by +DD ASP) and COVID replacement demand (our channel checks suggest this should hit over the next 6-12 months). Against a market cap of ~$370mm, this implies a de minimis enterprise value for a business with close to ~35% market share in the Consumer WiFi market and a highly profitable enterprise segment, where our checks suggest their Pro A/V product is a material contributor to top-line with margin contribution well above the Company’s consolidated levels.
2. Given the market is ascribing close to zero value for a market-leading business that’s generating cash, it’s imperative that the Company increases its repurchase authorization to at least $100mm – only 1.7mm shares remained authorized for buyback as of the end of Q1 2024. It’s difficult to fathom there are better capital allocation opportunities than buying back your own stock at close to zero enterprise value. Management has historically cited needing ~$125mm of cash to run the business, with the rest being up for “strategic uses.” There is almost no credible scenario in which the company, in its current state, doesn’t have over $200mm of excess cash above and beyond the $125mm by year-end. We recognize the Company is undergoing an internal review, given their new VP of Strategy hire from Amazon, but we struggle to see how more than $50mm of cash would be needed to invest behind areas of focus, especially when those dollars are competing against shrinking your equity for close to free. Furthermore, studying the historical profitability of NETGEAR reveals a company which has consistently generated between $60mm-$140mm of EBITDA going as far back as 2006, when revenues were ~15% lower and gross margins were in-line with expectations for 2025 and beyond. Management has alluded to getting back to mid-30s gross margins within the next 12-18 months, implying a path to $50mm - $80mm of EBITDA next year.
3. We urge the Company to create a strategic review committee to explore splitting up its Connected Home and NETGEAR for Business (NFB) segments. NFB has consistently posted contribution margins of 20% with double-digit revenue growth, prior to last year’s destocking anomaly and supply chain issues. Comparable public enterprise networking companies trade for 8x-10x forward EBITDA, and we believe the Company’s Pro A/V line, a gem buried within NFB, would be of significant interest to a potential acquiror. Decoupling the more cyclical, more competitive Connected Home segment from NFB would unlock significant value, given the extremely depressed market valuation of NETGEAR shares today. It is our view that the NFB segment alone could be worth over 100% of the current market capitalization, let alone the enterprise value!
While these capital allocation initiatives would create substantial shareholder value, we are further emboldened by our belief that there are significant and underappreciated tailwinds behind NETGEAR’s business fundamentals moving forward. Channel inventory levels are at historic and unsustainable lows, a WiFi 7 upgrade cycle is on the horizon, consumers are due to refresh their routing equipment, NETGEAR remains a market leader in home networking (~35% market share), and NETGEAR would be a material beneficiary of the bipartisan ROUTERS Act, which would reduce competition from ex-US players.
Shareholders would clearly benefit from aggressive and timely share repurchases in advance of that inflection. It’s unacceptable to sit on the sidelines with the magnitude of liquidity NETGEAR has at its disposal and with where shares currently trade. We urge the Board to consider the timeliness and gravity of the matter at hand.
Sincerely,
Marc Chalfin
Chief Investment Officer, Windward Management LP
