Gaming Reliance And Supply Chain Risks Will Challenge Diversification Yet Margins Should Gradually Improve

Catalysts

About Nexteq

Nexteq develops innovative, high-reliability computing and display technology solutions for gaming, broadcast and industrial customers worldwide.

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

• Although the gaming industry is gradually expanding with new regulated markets such as Brazil and a potential uplift from AI enhanced content, Nexteq is heavily exposed to a small number of large gaming OEMs. Acquisition related pauses and pricing pressure could cap unit pricing and constrain revenue growth even as volumes improve, limiting operating leverage and adjusted earnings.
• While the shift toward software rich platforms like LaunchPad creates an opportunity for higher quality recurring revenue, lengthy integration cycles and possible customer reluctance to standardise on a single vendor stack may delay uptake. This could hold back the targeted mix shift toward higher margin software and slow gross margin expansion.
• Although Nexteq is broadening into broadcast and industrial markets with differentiated HMI products such as Tactila and Prodeck, the long qualification cycles and conservative capital spending patterns in these sectors could mean that the anticipated diversification away from gaming dependence arrives later than planned. This may dampen medium term revenue growth and leave group margins vulnerable to gaming mix swings.
• While the group has built a robust global supply chain to mitigate tariffs and component shortages, ongoing chip constraints and the need to hold strategic inventory elevate working capital requirements and supply risk. This could compress net margins and weaken free cash flow if demand timing or product mix shifts unexpectedly.
• Although the three year plan targets higher gross margins and double digit EBITDA through innovation led growth and bolt on M&A, execution risks around CRM consolidation, sales force upskilling and timely completion of acquisitions may result in slower than expected scaling of new IP revenues. This could restrain both top line growth and margin progression over the next few years.

Assumptions

This narrative explores a more pessimistic perspective on Nexteq compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts. How have these above catalysts been quantified?

• The bearish analysts are assuming Nexteq's revenue will grow by 15.0% annually over the next 3 years.
• The bearish analysts assume that profit margins will increase from -3.7% today to 7.0% in 3 years time.
• The bearish analysts expect earnings to reach $8.4 million (and earnings per share of $0.13) by about December 2028, up from $-2.9 million today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 12.8x on those 2028 earnings, up from -23.7x today. This future PE is lower than the current PE for the GB Hospitality industry at 14.9x.
• The bearish analysts expect the number of shares outstanding to decline by 0.94% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 8.65%, as per the Simply Wall St company report.

Risks

What could happen that would invalidate this narrative?

• The business remains highly exposed to a small number of large gaming customers undergoing acquisitions and RFP processes, and if Nexteq loses share in the IGT North America tender or legacy volumes from Everi and Ainsworth fail to recover as expected, unit volumes could stagnate and constrain revenue growth and earnings over the medium term.
• Management’s long-term plan assumes successful diversification into broadcast, industrial and other verticals. However, long sales and integration cycles for Tactila and Prodeck, along with cautious post pandemic customer capex, could delay scaling these wins and leave the group over dependent on gaming, putting downward pressure on consolidated revenue and net margins.
• The shift toward software and new IP, such as LaunchPad and broader Nexteq owned solutions, underpins the three year margin and EBITDA targets. Yet if adoption is slower than anticipated or customers resist recurring models, the mix shift to higher value software may not materialize, limiting gross margin expansion and earnings growth.
• Ongoing semiconductor shortages and the need to carry strategic inventory across a global supply chain increase operational complexity. Any mismatch between stocked components and actual end market demand or pricing pressure could erode gross margin and weaken free cash flow and net profit over time.
• The three year growth plan relies on M&A, CRM consolidation and sales force upskilling to accelerate pipeline conversion. However, integration missteps, delays in completing acquisitions or ineffective deployment of new commercial structures could reduce the conversion of the opportunity pipeline into booked orders, slowing top line growth and leaving EBITDA margins below the targeted range.

Valuation

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

• The assumed bearish price target for Nexteq is £1.07, which represents up to two standard deviations below the consensus price target of £1.43. This valuation is based on what can be assumed as the expectations of Nexteq's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
  
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of £1.8, and the most bearish reporting a price target of just £1.07.
  
• In order for you to agree with the more bearish analyst cohort, you'd need to believe that by 2028, revenues will be $120.2 million, earnings will come to $8.4 million, and it would be trading on a PE ratio of 12.8x, assuming you use a discount rate of 8.6%.
  
• Given the current share price of £0.87, the analyst price target of £1.07 is 18.4% higher.
  
• 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.