AI-Driven Cloud And Defense Spending Will Drive Long-Term Demand For Network Testing

Catalysts

About Calnex Solutions

Calnex Solutions provides specialized test and measurement solutions that validate performance, timing and reliability across complex telecom, cloud, data center and defense networks.

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

• Ongoing bandwidth escalation from 400 gig to 800 gig and the planned 1.6 terabit Paragon Neo platform positions Calnex at the premium end of mission critical R&D test. This supports higher average selling prices and sustains gross margins near the mid 70 percent level.
• Rapid build out of AI driven cloud and data center infrastructure, including new PTP timing profiles and more complex architectures, is expanding demand for Calnex timing and network emulation tools. This underpins double digit top line growth potential from hyperscalers and colocation providers.
• Structural step up in global government and defense spending, and the shift to more networked, software defined defense systems, is opening high value program opportunities. Calnex is now building direct federal coverage and specialist channels, supporting recurring multi year revenue streams and operating leverage.
• Diversification beyond subdued telecoms into cloud, data center, and government customers, combined with a larger installed base and a push on support and maintenance contracts, is expected to increase the proportion of predictable software and service income. This should help smooth cash flows and stabilize net margins.
• Broadened partner network following the Spirent to Viavi transition, plus targeted senior hires in sales and markets, improves access to new verticals and regions. This should help accelerate order intake and allow incremental revenue to drop through at a high rate to EBITDA and earnings, given the largely fixed overhead base.

Assumptions

How have these above catalysts been quantified?

• Analysts are assuming Calnex Solutions's revenue will grow by 9.7% annually over the next 3 years.
• Analysts assume that profit margins will increase from 3.3% today to 14.1% in 3 years time.
• Analysts expect earnings to reach £3.5 million (and earnings per share of £0.03) by about December 2028, up from £623.0 thousand 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 34.2x on those 2028 earnings, down from 61.4x today. This future PE is lower than the current PE for the GB Communications industry at 61.4x.
• Analysts expect the number of shares outstanding to decline by 0.12% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 8.33%, as per the Simply Wall St company report.

Risks

What could happen that would invalidate this narrative?

• The telecoms market, which still underpins a large installed base and high value Lab Sync products, may remain subdued for longer than expected. This could limit upgrade cycles to 800 gig and delay adoption of the 1.6 terabit Paragon Neo, which would hold back revenue growth and constrain operating leverage on largely fixed overheads, pressuring earnings.
• The rapid and uncertain architectural shift in AI driven cloud and data center infrastructure could move towards solutions or standards that require different test approaches. In that case, Calnex’s current timing and emulation tools might capture only a small share of this secular growth, capping long-term revenue expansion and keeping net margins below the levels implied by the narrative.
• Execution risk in building and managing a much broader global partner and federal-focused channel network, including the transition from Spirent to Viavi and new defense resellers, could lead to slower than planned pipeline conversion and coverage gaps in key regions. This could depress order intake and delay the drop through of incremental revenue to EBITDA and earnings.
• Geopolitical and regulatory pressures, such as ongoing U.S.-China tensions and U.S. tariffs, may increasingly restrict access to North Asian customers and raise transaction frictions. This could undermine Calnex’s ability to grow in one of its core regions and potentially erode gross margins from the current mid 70 percent range.

Valuation

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

• The analysts have a consensus price target of £1.09 for Calnex Solutions 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 £25.2 million, earnings will come to £3.5 million, and it would be trading on a PE ratio of 34.2x, assuming you use a discount rate of 8.3%.
  
• Given the current share price of £0.43, the analyst price target of £1.09 is 60.1% 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.