Focusrite, the British global audio equipment company listed on AIM (#TUNE), published its annual results for the year ended 31 August 2021 this week. The company reported revenue growth of 34%, gross margin of 48% and operating margin of 21%. Their solid performance for the full year was explained by the continued success of their legacy products, new product integrations, an accelerating growth of their user base and further evolution of their routes to market.
In their annual report, the company cited supply chain issues as causing a decline in growth in the second half of the year, but what truly concerns me is demand for Focusrite's products, and whether this demand can be sustained. Will Focusrite continue to grow without the growth driver of the Covid-19 global lockdowns causing an increase in consumers purchasing their core brands? Will the newly acquired Martin Audio be able to encourage enough growth in their live markets to offset any decline in home studio purchasing?
In this article, I will analyse Focusrite six months on from my first article, and ask what investors should do now with the shares.
Recent Results Overview
In the recent results for the full year, Focusrite experienced revenue growth of 33.7%, with an organic constant currency growth rate of 28%, (it is worth noting that in FY’21, Martin Audio contributed a full year’s worth of revenue compared to just eight months in FY’20. FY'21 also includes the acquisition of Sequential at the end of April 2020, which contributed four months of revenue).
Revenue growth declined in the second half of the year (HY’21 saw 91% revenue growth compared to FY’21 of 34%). Focusrite explains this decline as partly due to the strong comparators in H2’20 during the initial lockdowns, but also due to the supply constraints experienced in the second-half of 2021 across many industries, but in particular for electronic chips, which are used in many of the Group’s products. The company reassured that their operations teams have secured supply and largely prevented stock outages with their supply partners, but that this caused a drag on their second half results. The company expects the problems caused by the supply chain constraints to continue throughout at least the first half of next financial year.
Gross profit margin was 48.4%, up from 46% in FY20 and from 42.3% in 2019. This steady increase is the result of several short and long-term factors. One such factor is Focusrite’s sales mix, as the company reduced sales through distributors and increased DTC sales (direct to consumer). In the long term, Focusrite expects this trend of margin expansion to continue as they shift away from distributors and the weighting from high margin product lines such as Adam Audio increases.
On the other hand, and explained further in the Risks section below, the Group is mindful of the impact of component shortages and increased freight chargers on future revenue and underlying gross margin.
Recent Results by Business Segment
The above table shows the segmented revenue for Focusrite’s business. The business is split into four segments:
FAEL (Focusrite Audio Engineering Limited)
ADAM Audio (acquired in 2019)
Martin Audio (acquired in 2019)
Sequential (acquired in 2020)
The FAEL segment (Focusrite Audio Engineering Limited) comprises Focusrite’s core products used in the recording and broadcasting of music or voice. The primary ranges in this segment are Scarlett and Clarett, which are Focusrite’s biggest selling products. The FAEL segment also includes the brand Novation and the brand Ampify. In FAEL, revenue increased by 24% to £124.4 million (FY20: £100.7 million), driven by ongoing strong demand across their user base.
ADAM Audio makes studio monitors of the type used by many of the Group’s customers. They were Focusrite’s first acquisition since the company went public in 2014 and were acquired in 2019. In the FY’21, revenue for ADAM has grown by 37% to £23.8 million (FY20: £17.4 million), with demand remaining strong across the range. This demand was initially boosted by Covid-19 and the rise in consumers buying audio recording equipment for home usage.
Martin Audio is a specialist in live speaker arrays. Martin Audio was acquired three months before the pandemic, which impacted their business significantly through the global suspension of live music. However, Focusrite provided positive feedback from Martin Audio in their annual report, stating that:
“[T]he commitment and agility with which the Martin Audio team has pivoted the focus of their business to Installed Sound (including places of worship, auditoria and nightclubs) and away from Touring and Festival Sound for which it was historically best known [has resulted in…] a great performance [...] in the 2021 financial year [...] Renewed demand from the live market promises further growth in 2022 and 2023 as the sound service companies reinvest in the new generation of Martin Audio event systems.”
As you can see from the table above, Martin Audio experienced 70% revenue growth in the year, with organic growth of 23%.
In my previous article on Focusrite, I believed that Martin Audio was a great strategic fit for the Group, a sentiment I reiterate today. Firstly, the company is based less than a mile away from Focusrite’s HQ in High Wycombe, and secondly, Focusrite has followed the Martin Audio business for many years. Also, the total sum of the acquisition was £39.2 million, which represented around 13 times EBITDA for Martin Audio in 2019, which was not overly expensive.
Finally, we have the figures from the recent acquisition of Sequential. Sequential is a legendary American synthesiser company founded and run by Grammy winner Dave Smith, who founded Sequential Circuits in 1974. Demand for analogue synthesisers is currently high, and Sequential revenues increased by 90% in the 12 months to August 2021 compared to the same period in the prior year.
Sequential’s acquisition was completed a month after my last article in March 2021, and the total consideration for the business was $24 million (c. £18 million), with an initial consideration of approximately $20 million of cash paid on completion and the remaining $4 million to be paid subject to certain performance conditions. The initial consideration was funded through existing cash resources and an additional £8 million drawdown on the existing £40 million revolving loan (used initially to purchase Martin Audio) from HSBC and NatWest. The $10 million (£8 million) of debt to fund the acquisition of Sequential has now been repaid.
The Group aims to help Sequential grow by providing them support in areas such as component sourcing, distribution logistics, customer support and marketing. Demand for Sequential products remains strong despite similar component availability challenges that the rest of the Focusrite Group are facing, and there are multiple new products anticipated throughout 2022.
Recent Results by Geography
North America, including the US and Canada, is Focusrite’s biggest market, accounting for 43% of total Group revenue. During the past year, North America grew by 47% to £74.6 million (FY’20: £50.8 million), which included a full year of Martin Audio and four months of Sequential revenue. On an organic basis (adjusted for FY’21 exchange rates and the impact of acquisitions) North American revenue was up 46% year over year, with all Focusrite’s brands experiencing strong growth. FAEL grew at 43% for the year, despite demand in the second half constrained by supply. Martin Audio saw markets begin to open and reported growth of 73% for the second half of the year. From the 1st September 2021, all of Focusrite’s brands will be consolidated under one company, Focus Group US. Focusrite explained that this decision should help to streamline processes and make navigating potential supply chain issues easier, as explained further in the Risks section below.
In EMEA (Europe, Middle East and Africa), Focusrite’s operations continue to grow, with dedicated offices in the UK and Berlin. Overall, EMEA accounted for 40% of Group revenue in FY’21, with revenue growing 23% year over year to £69.3 million (organic growth of 15%) with all brands reporting growth. The growth was led by Adam Audio products, at 35% for the year, as this brand was less impacted by the component shortage than Focusrite, which grew at 12% for the year.
In the ROW (Rest of World), which comprises Asia Pacific and Latin America, the Group’s revenue grew by 32% year on year, with organic growth of 25%. ROW accounted for 17% of the Group’s revenues. Asia Pacific grew at 28% year on year and was particularly strong for Martin Audio, with 76% growth across the year due to strong demand in the installed sector. Investments in sales and marketing delivered growth of 58% in Latin America.
Financial Performance Year-On-Year
Looking with a holistic lens at the financial metrics for Focusrite, I remain as impressed (if not more impressed) than on my first take back in March. Revenue has grown at a double-digit rate over the last five years, with a continuing strong performance in 2021. Gross margin has improved, largely due to the management team’s strong focus on improving margins (as opposed to a force outside their control) — in fact, we could argue management have faced headwinds in improving gross margins with supply shortages, so the YoY improvement here is great news.
Operating margins (on an unadjusted basis) have come in at the strongest level in Focusrite’s recent history and ROCE has greatly exceeded previous figures in 2021, coming in at 39%, a very strong result (this too is unadjusted).
Despite acquiring Martin Audio and Sequential very recently, Focusrite still maintains a healthy balance sheet with a very low Debt to Equity ratio. Focusrite management have been prudent in not overpaying for acquisitions, but also stretching the payment terms out over a couple of years to improve cashflow.
In summary, financially speaking, Focusrite remains in great shape, from both a profitability standpoint and in terms of capital allocation.
Focusrite is an enviously simple business. Its products are purchased by people looking to make quality music and Focusrite supplies its customers on that premise. Its goods do not have any externalities or sinful properties and it is in an industry that avoids regulation and, generally, its products make people happy. Given the above, Focusrite’s risk spectrum is fairly narrow in my opinion and it revolves around the critical questions of:
Do people want Focusrite’s products?
Can Focusrite supply people with the products they want?
Starting with the former, Focusrite’s demand has undoubtedly gone through a supercycle of late. The lockdown hobbyist effect boosted H1'21 revenues by 91%, driven by purchasing of Focusrite consoles and microphones. Herein lies the all important question, does the demand for Focusrite’s products continue to prevail in the years to come as the pandemic unwinds? Or does the hobbyist production start to wane and with it impact Focusrite’s top line?
In answer to this, we can firstly look at Focusrite’s own revenue growth falling from 91% in H1 to 33.7% for the full year (inc H2). Yes, some of the reduction in growth will be due to supply chains, however, demand will have been a factor here.
A look at Google Trends data would suggest worldwide interest in Focusrite branded products hit their peak in May 2020 (during the first lockdown) and then with a second peak in the Winter lockdown of 2020/2021. Search trends have since tailed off.
Gear4Music, a leading musical equipment retailer, published their results on the 16th of November. Below, you can see the data for their H1'22 unique website visitors. Site visits are down -11% YoY, showing a decline in interest from consumers in the UK.
These trends for the music sector do make me slightly uncomfortable, especially seeing as Focusrite has enjoyed such fantastic operating conditions — a worsening outlook for the underlying customer could be terrible for the share price. However, there are reasons to believe Focusrite can manage through a decline in demand for its products. The group is now much more diverse, with revenue streams in live and concert audio, commercial audio and more recently in audio software. During the pandemic, Martin Audio, which typically serviced live concert venues, managed to pull off a spectacular pivot to focus on other venues such as places of worship and commercial audio (cinema, offices).
Now, onto supply. The most notable challenge for the Focusrite Group during the last year was the global supply chain challenges, most notably component availability and constraints on logistics and shipping — as demand for silicon and wafer sky-rocketed, many companies found themselves unprepared for the increased demand in electronics.
Focusrite commented that they had weathered this storm well, with only small intervals of stock unavailability and moderate increases for costs of goods. While this is an ongoing issue, the Group has stated that they remain confident in their ability to supply a steady flow of product through their channel and ensure stock unavailability is kept to a minimum.
Logistics and freight issues have also been impacting the group. There have been increased lead times and costs to ship product to and from Focusrite’s contractor manufacturers and various warehouses. This has been exacerbated by port pandemic closures as well as increased demand for the availability of sea and air freight carriers and containers. This is also an ongoing economy-wide problem.
Whilst the two risks are important to focus on over the short term, I view the supply side risks as short term issues, which are unlikely to affect the business in the medium to longer term.
As stated in my previous article, I believed one of the key growth drivers for Focusrite was the democratisation of production. New technologies have enabled a dramatic reduction in cost for production, combined with the invention of apps to synthesise music also making production more accessible. Focusrite has spent significant resources translating its business model into one that compliments this new digital mode of production.
New ways of consuming audio broaden the revenue spectrum and total opportunity for Focusrite. The age of streaming services has also helped Focusrite, with the creation of new content categories, such as podcasts, driving growth in simple production equipment such as microphones. I expected that as the world becomes more technologically advanced, this type of content category expansion would continue creating opportunities for Focusrite.
The final growth driver for Focusrite is its acquisitions. Focusrite waited for a number of years after its stock market listing to acquire its first business, Adam Audio. It has followed this up with a number of bolt-on acquisitions to boost growth, all of which have been undertaken with little debt added to the business. Given organic growth rates over the last 5 years have also been strong, there is a good sign Focusrite’s purchases are immediately adding to their growth profile.
Summary and Valuation
In my article back in March, I commented "Focusrite trades at 33 times 2021's estimated earnings, which are likely to be beaten". Beat estimates it did, and despite the 40% rise in share price to 1590p, Focusrite still trades on 33x earnings for the last 12 month period. However, analysts still expect earnings to decline next year for Focusrite, thus, the multiple increases to 42x earnings in 2022.
There is no doubt Focusrite remains a high quality business, with exceptional financial metrics. Founder and chairman Philip Dudderige owns 32.8% of the equity, ensuring the company's policies are aligned to the long term interests of shareholders, and recent acquisitions have gone well, proving the company can diversify its end markets through bolt-ons.
However, compared to my article earlier in the year, I now think Focusrite’s risk/reward spectrum has shifted out of favour for the prospective investor. The elevated multiple, and the fact that for its core product (FAEL), the supercycle is now in the rear-view, I think investors are better off on the sidelines. In the long term, Focusrite will likely still prosper, and its Martin Audio division could drive growth for the business even in the instance that Focusrite products lose demand. I would be keen to revisit this story should the shares pull back a reasonable amount.
At the time of writing, The Twenties Trader did not own shares in Focusrite.
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