Attention Investors: Opportunity to Buy Avigilon Corp. at Bargain Prices Won’t Last Forever

Avigilon Corp. (TSX: AVO) has taken investors for a stomach-twisting, nauseating ride this year. While the S&P/TSX Composite Index (TSX: ^GSPTSE) has a one-year return of almost 10%, and the S&P/TSX Capped Information Technology Index (TSX: ^SPTTTK) has a one-year return almost 20%, Avigilon saw a decline of 25.5%. The reasons for this underperformance include concerns over the departure of key executive level personnel, margin pressure and concern over pricing, and patent infringement issues.

Departures of key personnel

There have been some executive departures but as the CEO explains it, it is a very entrepreneurial, fast-paced culture at Avigilon, and it’s focused on top talent. Back in the springtime, the company announced CFO Bradley Bardua’s resignation. This was the beginning of investor nervousness. The good news is that many high quality individuals have joined the company since. Mr. Wan Jung, a director of Avigilon and former CFO who retired a few years ago, has been named interim CFO.

The company recently hired former Hewlett Packard executive Margaret Herndon, with over 20 years of experience, as VP of Global Marketing and Communications and Dr. Mahesh Saptharishi as Chief Technology Officer, with over 17 years of experience in the field. Ultimately, I think that investors should not be overly concerned, as it seems the company has hired good people to replace those who have left.

I think the reaction to management turnover, which hasn’t really been excessively high, has been an overreaction because the stock was a high multiple stock and investors were jittery.

Margin pressure

It is well-known that Avigilon is investing in the business for longer term growth, and this has hit margins. It appears, in my view, to be a reasonable strategy and reasonable for investors to expect that the company will improve margins as spending decreases and sales growth is achieved.

While EPS growth has slowed to an expected 26% in 2014, it should strengthen as marketing and sales spending levels off. In fact, in 2015, the consensus expectation is for EPS of $1.07, for an almost 60% growth rate. Meanwhile, the stock is trading at a P/E of 21 times on 2014 expected EPS, and 13.4 times on 2015 expected EPS.

In terms of pricing, as of the latest quarter Avigilon’s main competitors, Hikvision and Axis Communications, have continued to increase their gross margins. Hikvision reported a 47.3% gross margin in Q2 2014, up from 47% in Q1, and 45.6% in Q4 2013. Axis reported a gross margin of 52% in Q2 2014 vs 50.5% in Q1. While this was also a result of a reduction in COGS, I have not seen sign of pricing pressure although the competitive environment is intense and continues to intensify. We will get an update from Avigilon’s competitor, Axis Communications, on October 16.

Patent issues

Patent infringement suits are par for the course in these types of businesses where innovation and intellectual property are the keys to success. There was a suit filed recently related to image memory and correlation analytics, and states that Avigilon’s “systems include at least such features as the detection of too many/too few objects in a space, tripwire, object addition/removal, object loitering and movement in a prohibited direction,” according to the complaint.

I think it would be more worrisome if the suit was related to Avigilon’s technology, but I think that this is important too, as it is an area where the company wants to increase its focus on that will be an important addition to its offering. An analyst from Cantor Fitzgerald has pointed out that this particular patent has been challenged more than once, and in each case a settlement was reached. That is probably what will happen.

Why buy?

Avigilon has been hammered by investors who have not been able to stomach the company’s rich valuation, and who have begun to anticipate problems in the business. While there may be some validity to some of the concerns out there, I think this is an example of a time when, as Warren Buffet says, investors should buy when others are fearful.

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Fool contributor Karen Thomas owns shares of Aviglion. Aviglion is a recommendation of Stock Advisor Canada.

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