Burning cash to fuel opportunities

DragonWave is burning through cash fast, while management is trying to find an extinguisher.

The networking hardware company believes continued tinkering with its Nokia Solutions Network (NSN) agreement, along with burgeoning opportunities in India and the United States, will help bust the company out of its string of consecutive quarterly losses.

“There’s a great competition going on in India right now. There’s a new entrant in India known as Reliance Industries,” says DragonWave’s CFO Russell Frederick. “We’ve been competing very hard for that business. Our position right now seems to be favourable. We haven’t won it yet, but we’re working hard on it.”

Reliance Industries, an Indian energy conglomerate, announced plans to build India’s most advanced telecommunications network in 2010. Since then, the company has spent US$3 billion on spectrum covering all of India. According to the Wall Street Journal, the project, which will need cell towers and other networking equipment to be completed, could cost as much as US$10 billion. If DragonWave gets its way, it will be a lead supplier for that development. However, Reliance is in no rush to announce when it will roll out its network.

“As they say, there are no clocks in India,” says Frederick. “The process of acquiring the contract has been going on for two years.  Everybody wants to get going, including them. So hopefully it’ll be a contributor, if not this fiscal year, then hopefully next fiscal year.”

Mobile carrier expansion in the U.S.

In the meantime, mobile carriers in the United States are releasing plans to expand their networks, as well. Shortly after Japanese telecom giant SoftBank purchased a controlling interest in Sprint, its CEO, Masayoshi Son, announced the mobile carrier would invest US$16 billion in network expansion. DragonWave’s management believes the company is in a good position to capitalize on Sprint’s expansion, because of its previous business history with the company.

“Everyone knows that we did a huge amount of business with Clearwire, [which was absorbed by Sprint],” says Frederick. “We do sell to Sprint today through our partner Samsung. Softbank also uses our products in Japan through the NSN agreement. So, all three of those parties who are part of Sprint know the DragonWave products.”

Capital investment in telecommunications has steadily declined over the last five years to US$69 billion from US$88.3 billion in the United States, according to a report by Euromonitor International. That’s not deterring Frederick’s optimism, however.

“I think Sprint in the United States is a big catalyst,” says Frederick. “I think if they start to do anything like the plans they’ve announced, soon that will spur more spending by other carriers in the United States. And then that will flow around the world.”

More telecom investment is good news

Increased telecommunication investment anywhere in the world is good news for DragonWave. Its customers are spread internationally, largely due to its agreement with NSN. Since its completion in 2012, the NSN agreement has accounted for a large portion of DragonWave’s revenues, but it’s also dragged with it significant operating costs.

The company’s last quarterly US$13.2 million cash deficit marked its eleventh straight. It’s a problem the company’s management team is diligently working to fix.

“We have to get to that cash flow break even point,” says Frederick. “I don’t want to describe that as easy, it’s certainly challenging.”

The company is in a restrictive cash position. An equity issue in September generated US$23.5 million to bolster its cash reserves. If the equity selloff was reported in the last quarter, DragonWave would have $32 million in cash on its balance sheet. On top of operating costs, the company also needs to tend to a US$8.9 million termination fee related to a cancelled service contract and deal with its US$15 million line of credit, which comes due at the end of May next year. The company’s burn rate is not sustainable.

The cost of integration

“The company will continue to burn cash during the integration of the NSN business,” says Desjardins telecommunications analyst Maher Yaghi through an email. “While we expect cash burn to stabilize as some of the inventory is sold in the upcoming quarters, the company’s sales funnel is still unpredictable. We expect DragonWave to continue to post negative earnings well into [the next fiscal year].”

Last quarter, the NSN channel brought in 61 per cent of the company’s revenue. And despite a poor experience from heavily relying on one client—Clearwire–in the past, management says it’s different this time around.

“NSN distributes [our products] to their customers around the globe. The NSN channel is actually quite a diversified stream of revenue, if you think about it from an end user point of view,” says Frederick.  “It’s not like a Clearwire where it was the single customer buying tons of products. When [Clearwire’s] capital funding stopped, of course the revenue for DragonWave started to dry up. In the case of NSN, we really don’t see that… the NSN channel is very powerful for us because NSN has thousands of sales people and offices all around the world.”

DragonWave’s NSN future

Analysts agree the NSN pact is important to DragonWave’s future success, according to a report by Desjardins Securities. However, expenditures related to the agreement need to be substantially cut. Management is restructuring the organization and has managed to cut its operating expenses by 50 per cent, compared to last year’s second quarter, to US$12.4 million. Yet, DragonWave still needs to tinker. It can’t keep up with its current expenditure rate.

In short, DragonWave has yet to see a positive return from the agreement. Its stock price reflects its struggles. On the TSX, DragonWave’s stock has tumbled to $1.28 from $3.38 when the deal was announced in May 2012. Last quarter, the company posted a US$10.5 million net loss. In the same period last year, the company only posted a loss of US$1.2 million, however DragonWave recorded $19.4 capital gain after the acquisition of NSN in the same quarter. Its revenues dipped likewise to US$22.5 million from US$44.2 million. Despite this, its management remains optimistic.

“It’s a very pivotal time for the whole industry,” says Frederick. “The technology that we have is the best technology in the world for the space we’re in. It’s really that market dynamic that will fuel DragonWave’s opportunity in the future.”