Like many companies that sell campus networking gear, Ubiquiti Networks saw a slowdown in 2Q20. Its Enterprise-related revenues grew only 4% Y/Y and were down 16% Q/Q. We reviewed the public material from its disclosures this morning, plus as we do during each of the quarters, we are making checks along the way because we assess Ubiquiti’s market share in many of its markets like Ethernet Switching, Enterprise WLAN, Consumer WLAN, routing and security.
The company experienced production delays in the quarter, primarily as a result of its main manufacturing site being located in southern China. It has established subcontract manufacturing relationships recently where parts are made in Vietnam and Taiwan. The company has been penalized with tariffs because many of its products are made in China, so it has an incentive to get out of the PRC. Its facility lease in China ends in a year, and we expect that Ubiquiti will begin using subcontract manufacturing outside of China increasingly.
Inventory and purchase obligations are at a record high. At the end of 1Q20, inventories had dropped, probably because of shutdowns in China, but inventories grew nearly 40% Q/Q in 2Q20. We believe that the company is expecting revenue growth in the future, based on its high inventory and purchase obligations.
The company attributes its growth to the expansion of distribution channels and expansion of its product line. Since the pandemic shutdowns hit, it appears that the company has not grown its distributor count appreciably. In previous quarters, it had grown its reseller and distributor counts, fueling growth. Coincident with the company’s supply chain difficulties, we have noticed that the company is having trouble getting important new products to volume. For instance, its Amplifi Alien 802.11ax product, while introduced months ago, is unavailable for purchase. We have evidence that some volume was available during 2Q20, though. We see this type of difficulty getting products to volume as related to the sequential growth challenges the company experienced. But, the company has record purchase obligations, so we think it is just a matter of time before it has 802.11ax consumer – and enterprise-class – WLAN products in the market. Our hunch is that by 2H20, the company will have 802.11ax enterprise WLAN products in the market.
Speaking of WLAN, since Ubiquiti is selling primarily 802.11ac products at a time when the market is moving towards the newer generation 802.11ax, this is effectively shrinking Ubiquiti’s addressable market as about 1/3rd of enterprise Access Point revenue is related to 802.11ax. Additionally, the company has significant exposure to smaller customers, which are being hurt more during the shutdowns than larger ones.
Ubiquiti has been a share-taker in the enterprise WLAN market for many years. But, with the short-term challenges it is experiencing (supply chain, distribution, older product portfolio, customer exposure), its share-taking ended in 2Q20. It looks like the company is taking steps to address the supply chain and product refreshes. However, its exposure to smaller customers and its challenges in expanding distribution are more difficult to fix during the pandemic.