Rising Defense Budgets And BVLOS Regulations Will Eventually Pressure Margins And Competitive Position

Catalysts

About Elsight

Elsight provides high reliability connectivity and cloud software for uncrewed and autonomous systems across defense and commercial markets.

What are the underlying business or industry changes driving this perspective?

• Rising defense budgets and rapid adoption of uncrewed platforms could normalize over time as conflicts de escalate or fiscal pressures mount, leaving Elsight with a cost base and sales footprint sized for peak demand and compressing revenue growth.
• Greater regulatory clarity for Beyond Visual Line of Sight operations is likely to invite larger telecom, satellite and defense primes to productize integrated connectivity stacks, eroding Elsight's pricing power and pressuring hardware gross margins.
• Customers are still placing relatively small, sub multimillion dollar commercial orders while Elsight invests aggressively in global sales, conferences and regional manufacturing options, creating a risk that operating expenses outgrow the pace of contract scale up and squeeze net margins.
• The model depends heavily on high margin recurring software and data fees, yet buyers facing their own cost inflation may push to internalize connectivity or renegotiate bundles as fleets scale, undermining the sustainability of current earnings multiples.
• Management is pursuing new product lines and an additional business unit in large adjacent markets that will require upfront R&D and go to market spending, and any delay in meaningful 2027 plus revenue could dilute returns on capital and weigh on future earnings growth.

Assumptions

How have these above catalysts been quantified?

• Analysts are assuming Elsight's revenue will grow by 131.5% annually over the next 3 years.
• Analysts assume that profit margins will increase from -50.6% today to 31.4% in 3 years time.
• Analysts expect earnings to reach $22.5 million (and earnings per share of $0.06) by about December 2028, up from $-2.9 million today.
• In order for the above numbers to justify the price target of the analysts, the company would need to trade at a PE ratio of 13.5x on those 2028 earnings, up from -142.9x today. This future PE is lower than the current PE for the AU Electronic industry at 51.7x.
• Analysts expect the number of shares outstanding to grow by 0.39% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 7.97%, as per the Simply Wall St company report.

Risks

What could happen that would invalidate this narrative?

• Sustained growth in global defense spending with a rising share directed to uncrewed systems, including NATO commitments to higher defense budgets and concrete programs like Greece planning large scale drone production, could underpin long term demand and support continued revenue expansion.
• Regulatory progress such as the FAA’s Part 108 BVLOS framework and increasing commercial deployments in logistics, inspection, agriculture and drone as first responder services may unlock scaled adoption of autonomous platforms, driving recurring connectivity and software revenues higher.
• Elsight’s transition to profitability, exceptionally high blended gross margins of around eighty percent across hardware and software, and strengthening positive cash flow could improve operating leverage and support long term earnings growth and net margins.
• A substantial and growing pipeline of approximately one hundred and fifty seven million dollars in tangible opportunities, combined with repeated follow on orders from existing customers and design win positions, may translate into sustained contract conversions and rising revenue over the next several years.
• Expansion into adjacent products such as non GNSS navigation, the creation of a new business unit targeting a large twenty billion dollar addressable market, and potential inorganic growth via acquisitions may diversify the business model and add incremental revenue and earnings streams beyond the current core.

Valuation

How have all the factors above been brought together to estimate a fair value?

• The analysts have a consensus price target of A$1.99 for Elsight based on their expectations of its future earnings growth, profit margins and other risk factors.
  
• In order for you to agree with the analysts, you'd need to believe that by 2028, revenues will be $71.8 million, earnings will come to $22.5 million, and it would be trading on a PE ratio of 13.5x, assuming you use a discount rate of 8.0%.
  
• Given the current share price of A$2.87, the analyst price target of A$1.99 is 44.5% lower. Despite analysts expecting the underlying business to improve, they seem to believe the market's expectations are too high.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.