Douglas Rissing
Shares of Axon Enterprises (NASDAQ:AXON) have been absolutely on fire. The producer of Taser has seen significant operating momentum, with investors aggressively pricing in its strong track record and rosy prospects.
While I am greatly appreciative of the business, its management, great track record and outlook, I am barking at these very premium valuations, not leaving a compelling risk-reward in my view.
Transforming Public Safety With Technology
The paragraph header is the mission of the company, formerly known as Taser. The vision of the company is a world in which bullets are obsolete, in which social conflict is reduced, in a world in which people have access to a fair and effective justice system.
The company is managed by a founder-led management team which has a track record of scaling industries, as frankly I am deeply impressed with their achievements.
The company is best known from its Taser device, being a less-lethal option compared to guns, used to de-escalate situations, with the company believing on the cusp of global adoption. This hardware is complemented by the Axon cloud, a cloud-powered software suite for digital evidence management, productive and real-time operations.
All this is complemented by sensors and other hardware devices, including body cameras, in-car cameras, sensors, all mission-critical equipment for daily police operations.
These solutions carry a big flywheel effect, with real synergies seen between product categories. Used by the US state and many local agencies, the company still has many federal, international and even enterprise growth market opportunities ahead. This is certainly the case as the company works on other product categories as well, including air surveillance, response mechanisms, VR training. US cases surpass police departments, expected to be sued by fire departments, medical emergency agencies, and correction facilities.
On top of expansion into adjacent product categories, and moving into other domestic clients, there are huge overseas expansion opportunities, at the first instance notably with police forces across the globe.
On a more than $1.5 billion revenue base in 2023, the company is quite well diversified. The Taser business is the largest, responsible for about 40% of sales. Axon Cloud & Services makes up about a third of sales, complemented by the Sensor & other application. These achievements are complemented by stable and solid EBITDA margins around 20% of sales.
A Great Growth Story
Over the past decade, Axon has seen spectacular growth. Sales of $1.56 billion in 2023 were tenfold the $164 million in sales reported back in 2014. Irony will it that the company posted operating earnings around 20% back in 2014, and after modest losses around the pandemic period, margins have recovered to about 10% of sales today. In all honesty, investors have seen dilution to the tune of around a third over the same period in time, due to substantial stock-based compensation expenses.
All this has yielded spectacular results. A $20 share as recent as 2017, hit the $100 mark in 2020, and the $200 mark in the year thereafter. Shares fell back to the $100 mark in 2022, and rallied to the $250 mark at the start of this year. Ever since, shares have risen another 50% year to date to current highs around $380 per share.
This is driven by continued momentum in the business. In February, the company posted a 31% increase in full year sales to $1.56 billion. Operating margins improved towards 9.9% of sales, a 210 basis point improvement on the year before, but still relatively modest on a historical basis of course. GAAP earnings improved to $2.31 per share, but this was quite adjusted with interest income on the one side, offset by one-time costs, among others, on the other side.
Important is that the guidance called for continued growth, with sales seen up 20-24% to $1.88-$1.94 billion, and EBITDA seen between $410 and $430 million. This compares to a $329 million adjusted EBITDA number posted in 2023. Realistic earnings growth for 2024 was limited, as stock-based compensation expenses were expected between $205-$220 million, in part the result of an enhanced compensation plan for lower-wage employees. This compares to a $131 million expense in 2023!
The company was off to a very strong start, with first quarter sales up 34% to $461 million. The company subsequently raised the full year sales guidance by $50-$60 million to $1.94-$1.99 billion. Adjusted EBITDA was seen up $15-$20 million to $430-$445 million.
Second quarter sales grew even by 35% to $504 million, as the company raised the full year sales guidance by sixty million to $2.00-$2.05 billion. The EBITDA guidance was hiked by as much as $30 million to $460-$475 million.
Valuation Thoughts
By now, the 77.5 million shares of the company value equity of the business at $29.5 billion, based on a $380 share price. This includes a gross cash position of close to a billion here, for a $28.5 billion operating asset valuation.
This shows that expectations have run really high, with shares awarded a 14 times sales multiple here. The valuation discussion is even worse. The company posted second quarter adjusted earnings of $1.20 per share, but this is a highly adjusted earnings number as it excludes for huge stock-based compensation expense, which is seen even higher for the year now.
Adjusted for this, earnings trend at just around half a dollar, which suggests that the core business is posting earnings of realistically around $2 per share per annum. This is even overstated, as some of these GAAP profits include interest income on the net cash holdings.
Needless to say, shares trade at around a 200 times realistic earnings multiple, marking huge expectations here.
What Now?
The reality is that the valuation is based on continued growth. The company itself touts a $77 billion total addressable market, as a current $2 billion revenue base is still small in relation to this.
If the company can grow sales by 15% per annum in the coming decade, this might easily become an $8 billion business by 2035, as I certainly believe that historical margins around 20% of sales can easily be reachable again. This comes as the company currently sees subdued earnings amidst investments into new areas. Such an achievement could yield pre-tax profits of $1.6 billion, after tax at $1.2 billion, for earnings around $15 per share.
If that is realistic, shares today trade at 25 times earnings, seen ten years ahead in time! Clearly, investors have higher hopes. If the company can grow sales by 25%, sales could grow to $18 billion, as similar margins would allow for earnings around $35 per share.
It seems that such kind of earnings are expected by 2035 in the current share price, as frankly 25% growth in the coming ten years is quite a stretch, too much for me to see a solid risk-reward proposition here.
On the other hand, current growth rates come in around 35% per annum, with continued impressive growth rates certainly being possible given a current TAM of $77 billion, likely only set to grow further as time passes. This comes as the Taser was just the start with Draft One having huge potential, as bodycams furthermore have the capability to create police reports themselves, with the quality even surpassing that of reports written by actual officers.
Hence, shares do not need a catalyst, but continued innovation, product introduction, and (international) adoption to maintain current growth rates. If these solutions have such great payback periods and expertise, while being integrated across solutions, the company remains on track to eat the lunch of its competitors.
Amidst too aggressive stock-based compensation being doled out here, especially this year, I am very cautious on the shares here. While I am greatly appreciative of the business, its management team, past performance and long term outlook, I am very cautious but appreciative of the business.
