Windward Management Issues Letter to NETGEAR Board Strongly Advising the Immediate Repurchase of at Least 25% of the Shares Outstanding (~$100M) & the Formation of a Strategic Review Committee to Examine Splitting off and/or Selling the NFB Segment

Rhea-AI Summary

Windward Management has issued a letter to NETGEAR's board, recommending a share repurchase of at least 25%, equating to around $100 million, and the formation of a strategic review committee to consider splitting or selling the NFB segment. Windward highlights NETGEAR's robust cash position, with $289 million in cash and short-term investments against a market capitalization of $370 million. Despite a challenging environment, Windward believes NETGEAR's upcoming WiFi 7 upgrade cycle, normalized inventory levels, and strong market leadership in consumer WiFi (35% share) could significantly enhance shareholder value. They predict a 150% upside for shares over the next 12-18 months.

Positive

• NETGEAR has $289 million in cash and short-term investments against a market cap of $370 million.
• Windward predicts a 150% share price upside over the next 12-18 months.
• The WiFi 7 upgrade cycle and normalized inventory levels are expected to boost sales.
• NETGEAR holds a 35% market share in the consumer WiFi market.
• Splitting or selling the NFB segment could unlock significant shareholder value.

Negative

• The company's enterprise value might be negative by the end of 2024.
• There is uncertainty surrounding the EBITDA trajectory for the second half of 2024, with a conservative estimate of breakeven.
• Past operational decisions under the previous CEO contributed to current financial challenges.
• The market is currently ascribing almost no value to NETGEAR’s business despite its market leadership.
• Management needs to address the significant liquidity position, which is seen as unacceptable by Windward.

Insights

Financial Analyst

Windward Management has put forth a compelling argument for NETGEAR to undertake significant capital allocation initiatives. The recommendation to repurchase at least $100M worth of shares—representing around 25% of shares outstanding—would be a highly accretive move given the company's current valuation. NETGEAR's cash reserves of over $289M compared to a market cap of approximately $370M underscore a significant disconnect between the market's valuation and the company's actual financial health.

A share buyback program at this scale would likely bolster the stock price by reducing the number of shares in circulation, thus increasing earnings per share (EPS). Additionally, the favorable free cash flow guidance for 2024, despite recent headwinds, suggests that NETGEAR is on a path to financial stabilization and growth, which should further enhance shareholder value.

Moreover, the proposal to split off the highly profitable NETGEAR for Business (NFB) segment could unlock substantial value. According to Windward, this segment alone might be worth the entire market cap of the company, suggesting that the current stock price severely undervalues NETGEAR's assets. Investors should consider these factors when evaluating the company's long-term potential.

Market Research Analyst

From a market perspective, Windward's letter highlights several upcoming catalysts that could significantly impact NETGEAR's valuation. The anticipated WiFi 7 upgrade cycle is particularly noteworthy. Historically, such technology upgrades drive substantial growth in unit sales and average selling prices (ASPs), which could lead to higher revenues and improved margins for NETGEAR's consumer WiFi segment. This upgrade cycle, combined with the COVID replacement demand and channel restocking, presents a robust growth opportunity over the next 6-12 months.

Additionally, the potential passage of the bipartisan ROUTERS Act could limit competition from international players, thereby enhancing NETGEAR's competitive position in the market. The market currently seems to be overlooking these positive tailwinds, which could lead to a significant re-rating of the stock once these factors materialize.

Furthermore, the suggestion to decouple the cyclical Connected Home segment from the steady and profitable NFB segment could provide clarity and attract different investor bases, further unlocking value.

• Current net cash is equal to ~80% of NETGEAR’s market cap & recent company-provided 2024 free cash flow guidance implies a de minimis, to potentially negative, enterprise value by year-end
• Windward believes splitting off the NFB segment would create significant shareholder value as diligence and comp analysis suggest this historically growing and highly profitable enterprise business is likely worth the entirety of the market cap, let alone the paltry enterprise value
• Market is ascribing almost no value to NETGEAR’s business, despite the Company being a market leader in Consumer WiFi (~35% market share) and possessing a hidden gem in NFB
• Implores board to act swiftly to reward shareholders with highly accretive actions ahead of a significant and impending fundamental inflection over the next 6-12 months: WiFi 7 upgrade cycle, COVID replacement cycle/demand, channel restocking off of historically low inventory levels, and a potential easing of competitive dynamics, should the bipartisan ROUTERS Act gain traction
• Windward believes shares have 150%+ upside potential over the next 12-18 months as excess cash is used accretively to shrink dirt-cheap shares, Consumer segment (CHP) returns to normal profitability and the unrecognized value of (NFB) is highlighted/monetized

MIAMI BEACH, Fla.--(BUSINESS WIRE)-- Windward Management LP today issued the following open letter to the board of directors of NETGEAR Inc.

May 24, 2024
NETGEAR, Inc.
Attn: The Board of Directors
350 E. Plumeria Drive
San Jose, CA 95134

Members of the Board of Directors,

Windward Management LP (collectively with its affiliates, “Windward”, “we”, “our” or “us”) controls ~4.2% of the outstanding common shares of NETGEAR Inc. (NASDAQ: NTGR) (“NETGEAR” or the “Company”). Windward, and its CIO Marc Chalfin, has a record of suggesting accretive and value enhancing measures to both management teams and boards, and we are highly dedicated to creating and augmenting value for all shareholders, including our clients.

We appreciate the Company and the Board’s efforts to navigate a multitude of headwinds coming out of COVID, including substantial supply chain disruption and working down significantly bloated inventories from a COVID-driven “hangover”; only further amplified by massive multi-quarter channel destocking, and an increasingly challenged macroeconomic environment. If that were not enough, this litany of headwinds was only further exacerbated by some misguided operational decisions under the prior CEO/Founder, and thus far we are aligned with several of the operational business decisions under the new CEO CJ Prober to reverse some of the damage shareholders have recently suffered through. Namely, pulling forward destocking to align sell-in with sell-through ahead of the imminent WiFi 7 upgrade cycle and going back to a “good, better, best” approach to recapture lost shelf space, both we believe are smart decisions. However, we strongly believe that the cash position of the business in the context of the Company’s current valuation necessitates swift and decisive actions on the capital allocation front:

1. As of the end of Q1 2024, NETGEAR has over $289mm of cash and short-term investments on its balance sheet vs. a current market capitalization of ~$370mm. The company has guided to generating meaningful free cash flow for the remainder of the year, rendering the pro forma year-end enterprise value as being potentially less than zero. On the Company’s last earnings call, management indicated they expect to generate free cash flow of $8mm-$15mm in Q2 2024 (despite ripping the band-aid on significant channel destocking/-EBITDA) and will generate material free cash flow in the back half, as a result of inventory turns normalizing to ~4x from ~2x currently. While the trajectory of 2H 2024 EBITDA remains unclear, conservatively assuming breakeven EBITDA in 2H implies the Company’s year-end net cash balance will be ~$350mm. We would argue there is more risk to the upside, as our estimates assume EBITDA is $10mm lower YoY in 2H, despite lapping trough inventory levels and with tailwinds from the WiFi 7 upgrade cycle (last upgrade cycle drove double-digit unit growth augmented by +DD ASP) and COVID replacement demand (our channel checks suggest this should hit over the next 6-12 months). Against a market cap of ~$370mm, this implies a de minimis enterprise value for a business with close to ~35% market share in the Consumer WiFi market and a highly profitable enterprise segment, where our checks suggest their Pro A/V product is a material contributor to top-line with margin contribution well above the Company’s consolidated levels.

2. Given the market is ascribing close to zero value for a market-leading business that’s generating cash, it’s imperative that the Company increases its repurchase authorization to at least $100mm – only 1.7mm shares remained authorized for buyback as of the end of Q1 2024. It’s difficult to fathom there are better capital allocation opportunities than buying back your own stock at close to zero enterprise value. Management has historically cited needing ~$125mm of cash to run the business, with the rest being up for “strategic uses.” There is almost no credible scenario in which the company, in its current state, doesn’t have over $200mm of excess cash above and beyond the $125mm by year-end. We recognize the Company is undergoing an internal review, given their new VP of Strategy hire from Amazon, but we struggle to see how more than $50mm of cash would be needed to invest behind areas of focus, especially when those dollars are competing against shrinking your equity for close to free. Furthermore, studying the historical profitability of NETGEAR reveals a company which has consistently generated between $60mm-$140mm of EBITDA going as far back as 2006, when revenues were ~15% lower and gross margins were in-line with expectations for 2025 and beyond. Management has alluded to getting back to mid-30s gross margins within the next 12-18 months, implying a path to $50mm - $80mm of EBITDA next year.

3. We urge the Company to create a strategic review committee to explore splitting up its Connected Home and NETGEAR for Business (NFB) segments. NFB has consistently posted contribution margins of 20% with double-digit revenue growth, prior to last year’s destocking anomaly and supply chain issues. Comparable public enterprise networking companies trade for 8x-10x forward EBITDA, and we believe the Company’s Pro A/V line, a gem buried within NFB, would be of significant interest to a potential acquiror. Decoupling the more cyclical, more competitive Connected Home segment from NFB would unlock significant value, given the extremely depressed market valuation of NETGEAR shares today. It is our view that the NFB segment alone could be worth over 100% of the current market capitalization, let alone the enterprise value!

While these capital allocation initiatives would create substantial shareholder value, we are further emboldened by our belief that there are significant and underappreciated tailwinds behind NETGEAR’s business fundamentals moving forward. Channel inventory levels are at historic and unsustainable lows, a WiFi 7 upgrade cycle is on the horizon, consumers are due to refresh their routing equipment, NETGEAR remains a market leader in home networking (~35% market share), and NETGEAR would be a material beneficiary of the bipartisan ROUTERS Act, which would reduce competition from ex-US players.

Shareholders would clearly benefit from aggressive and timely share repurchases in advance of that inflection. It’s unacceptable to sit on the sidelines with the magnitude of liquidity NETGEAR has at its disposal and with where shares currently trade. We urge the Board to consider the timeliness and gravity of the matter at hand.

Sincerely,
Marc Chalfin
Chief Investment Officer, Windward Management LP

View source version on businesswire.com: https://www.businesswire.com/news/home/20240529218081/en/

Theodore Woo

Chief Operating Officer

(786) 206-3126

ted@windwardmg.com

Source: Windward Management

FAQ

What is Windward Management advising NETGEAR to do?

Windward Management is advising NETGEAR to repurchase at least 25% of its shares, worth around $100 million, and create a strategic review committee to consider splitting or selling the NFB segment.

How much cash does NETGEAR currently have?

As of Q1 2024, NETGEAR has over $289 million in cash and short-term investments.

What is the projected upside for NETGEAR shares according to Windward Management?

Windward Management predicts a potential upside of 150% for NETGEAR shares over the next 12-18 months.

What market share does NETGEAR hold in the consumer WiFi market?

NETGEAR holds a 35% market share in the consumer WiFi market.

What financial issue did Windward Management highlight about NETGEAR?

Windward Management highlighted that NETGEAR’s enterprise value could potentially be negative by the end of 2024.

Why does Windward Management believe splitting the NFB segment is beneficial?

Windward Management believes splitting the NFB segment would unlock significant shareholder value as it is highly profitable and potentially worth the entirety of NETGEAR's market cap.

What strategic actions does Windward Management suggest for NETGEAR?

Windward suggests aggressive share repurchases and exploring the split or sale of the NFB segment to unlock value.

What external factors could benefit NETGEAR according to Windward Management?

The upcoming WiFi 7 upgrade cycle, normalized inventory levels, and the potential easing of competitive dynamics from the ROUTERS Act could benefit NETGEAR.