Description

Allot Communications (ALLT) – Back from the Dead

Allot Communications is a hardware and software provider of solutions that allow its customers visibility into their network traffic and control of that traffic based on customer-written rules.  This capability is known as Deep Packet Inspection (DPI) and Allot was one of the first players into this market.  Originally used by carriers to slow down or stop traffic going to or from specific websites, the technology is now used for general visibility, differentiating rate plans, and security functionality.

The original DPI vendors, Allot, Sandvine Corp (SVC.CN), and Procera Networks enjoyed high multiples in the 2011 – 2013 period when their revenues were growing quickly due to carriers efforts to control traffic on their networks.  At its peak, Allot was a $30 stock (compared to $5.37 today).  Since then, investors have soured on these companies as revenue growth has slowed, impacting margins as well.  Allot had 17.1% operating margins in 2012 compared with a slight loss for 2015E. 

The decrease in revenue growth was caused by increased penetration into the market and by the net neutrality issue in the United States.  Net neutrality means that the carriers cannot give preferential treatment to any sites’ traffic on their networks.  For example, Verizon cannot throttle the speed of a small website relative to the speed of Netflix on its network or vice versa.  DPI hardware had been used to enable this differentiation so the net neutrality uncertainty and finally, net neutrality laws, caused a stoppage of DPI sales in the US, which had been a large market previously.

So where does this leave Allot today?  The company is proceeding with two revenue driving initiatives that we feel will reignite revenue growth and margin expansion.  The first driver is the use of the company’s DPI hardware and software to enable security functionality.  Allot has been selling security functions such as parental control, anti-malware, anti-spam, and anti-DDoS (distributed denial of service attacks) over the past year, and this accounts for 30% of the company’s revenue today.  Vodafone is Allot’s flagship customer in this segment and it has rolled out these services to millions of its customers (https://securenet.vodafone.com).  In addition, the company is now targeting enterprises and cloud providers as customers in addition to their traditional service providers.  These new customers can benefit from Allot’s security portfolio as well as its visibility products used to enforce service level agreements (SLAs).    

Given the demand for security products and Allot’s entrance into the new cloud provider and enterprise markets, we feel that the company can grow at a 20% clip for the next few years.  Couple that with good expense control and the company could reach a 14% EBIT margin in 2017.  This would translate to a 3.1x EV / EBIT ratio today which is extremely cheap. 

In addition to abundant earnings power, Allot could also make a nice M&A target to a larger hardware player.  Cisco, Alcatel-Lucent, Huawei, and others could all benefit from Allot’s DPI expertise, as could security players such as Check Point or Fortinet.  

With 2/3 of the company’s market share in cash and with minimal losses today, Allot presents an extremely good risk / reward at these levels.  In addition, Allot has a decent amount of sell-side coverage but they are uniformly negative on the company so the only change in sentiment could be for the good.

Catalyst

Allot's Q4 revenue estimate represents a significant increase from Q3 and the market is waiting to see if they can hit it.  If they do, the stock will likley go higher.  Also, the company could be acquired by a larger security or networking player.