Fiber Build Constraints And AI Transition Will Challenge Execution Yet Ultimately Support A Stronger Business

Catalysts

About Calix

Calix provides a platform, appliances, cloud software and managed services that help broadband providers run their networks and grow subscriber relationships.

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

• Although fiber remains the primary technology supported by US broadband funding programs such as BEAD, Calix still needs build crews and service providers to expand deployment capacity, which can slow the conversion of the identified US$1b to US$1.5b opportunity into appliance revenue and subscriber driven software fees.
• While the third generation Calix platform and Agent Workforce Cloud are in place and migrating more than 300 customers, the company must prove it can convert this broader AI driven toolkit into consistent upsell activity. Otherwise, software and services revenue and gross margin expansion could lag expectations.
• Although remaining performance obligation sits at US$385 million and provides solid visibility, a large portion of future growth depends on broadband providers continuing to add subscribers on top of these contracts. Any slowdown in subscriber additions would limit recurring software growth and temper earnings momentum.
• While Calix is starting to pursue Tier 1 and large international customers with private cloud deployments and AI centric offerings, these 18 to 24 month sales cycles and heavy upfront effort can defer revenue contribution and keep operating expenses elevated relative to near term earnings.
• Although management has shifted all cloud activity to Google Cloud and expects software and services gross margins to move past 70% once dual cloud costs fall away, the current overlap in cloud spending and increased AI development investment can compress net margins until the newer AI and platform capabilities translate into higher per subscriber fees.

Assumptions

This narrative explores a more pessimistic perspective on Calix 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 Calix's revenue will grow by 12.2% annually over the next 3 years.
• The bearish analysts assume that profit margins will increase from 1.8% today to 10.0% in 3 years time.
• The bearish analysts expect earnings to reach $141.0 million (and earnings per share of $2.06) by about January 2029, up from $17.9 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 36.1x on those 2029 earnings, down from 165.5x today. This future PE is greater than the current PE for the US Communications industry at 31.7x.
• The bearish analysts expect the number of shares outstanding to grow by 0.18% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 8.08%, as per the Simply Wall St company report.

Risks

What could happen that would invalidate this narrative?

• Industry build capacity is finite, so even though management cites a US$1b to US$1.5b BEAD opportunity, the same construction crews are already occupied on non BEAD projects. This could limit how much of that funding actually turns into incremental appliance shipments for Calix, affecting revenue and earnings.
• The new Agent Workforce Cloud and third generation platform depend on customers adopting more software and AI driven workflows over time. If broadband providers are slow to change their operating models or hesitate to pay higher per subscriber fees, the expected shift toward higher margin recurring software and services could fall short, affecting gross margin expansion and net margins.
• Management highlights long Tier 1 and international sales cycles of 18 to 24 months and acknowledges that they have not built material revenue from these opportunities into near term numbers. If those large prospects take longer than expected to convert or choose internal solutions, elevated operating expenses to pursue them could weigh on profitability and earnings.
• During the transition to the third generation platform, Calix is running dual cloud environments and increasing AI related R&D. If the company does not achieve the intended scale benefits or subscriber upsell to offset these costs, software and services margins and free cash flow could come under pressure, limiting net margins.
• Management is confident that fiber will capture most of the long term broadband build and views competition as more intense between fixed wireless and satellite. Any change in policy, technology preference or funding mix that slows fiber deployments, particularly for smaller regional providers where Calix is strong, could reduce appliance demand and subscriber growth on the platform, impacting revenue and earnings.

Valuation

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

• The assumed bearish price target for Calix is $60.0, which represents up to two standard deviations below the consensus price target of $79.5. This valuation is based on what can be assumed as the expectations of Calix'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 $90.0, and the most bearish reporting a price target of just $60.0.
  
• In order for you to agree with the more bearish analyst cohort, you'd need to believe that by 2029, revenues will be $1.4 billion, earnings will come to $141.0 million, and it would be trading on a PE ratio of 36.1x, assuming you use a discount rate of 8.1%.
  
• Given the current share price of $44.67, the analyst price target of $60.0 is 25.5% 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.