Should you buy, hold or sell Megaport shares?

Megaport Ltd (ASX: MP1) is a telecommunications network provider dedicated to establishing interconnections between data centres, public clouds and or services via their network.

Using MP1 means that customers can access these services without the need for them to invest in building, buying, or configuring their own physical network infrastructure. The core aim of MP1 is to revolutionise how customers purchase networking by aligning their bandwidth consumption with cloud computing usage.

Instead of the traditional approach to networking where customers had to buy connectivity for each site and manage their own connections to those sites and different services, MP1 allows customers to add services or connections effortlessly once connected to the Megaport fabric through the click of a button.

More recently, MP1 has started providing other services that sit on top of their network fabric like the cloud-to-cloud connectivity (Megaport cloud router) and their SD-WAN offering. There are plans for other services to sit alongside these in the future.

Strategy and outlook

The initial phase of the MP1 journey was to build out their network infrastructure. MP1 needed to establish a presence in data centres around the world ('Points of Presence', or 'PoPs'), focusing on three regions; APAC, Europe and North America.

To make it compelling for customers to use MP1 as their connectivity partner, they needed to have access to services via their network like cloud service providers such as Amazon AWS, Microsoft Azure, Google Cloud, a lot of whom you could not connect to directly as a customer.

Having reached a level of scale globally, MP1 started to build out other products on top of the network fabric to increase the number of services a customer would ultimately use.

Initially MP1 pursued a direct sales model, aided by the data centres where MP1 would install their PoPs. Success in this phase was defined as the number of data centres they are connected to, the number of ports they sold in each data centre and how many services they connected to each port.

The direct sales channel, while effective, was particularly hard to scale efficiently, especially since the ticket price of the service is reasonably small compared to other enterprise purchases. MP1 decided to include an indirect sales channel as part of their go-to-market strategy, the theory being that their channel partners would start to drive a meaningful acceleration in the adoption of ports and services offered by MP1.

Returns

Investors have had a bumpy ride over the past year. MP1 started the year trading at $6.00, hit a low of $3.77 at the end of March, and above $11 in July. The share price volatility wasn't completely irrational, as quarterly updates provided by the company have been mixed and sentiment related to execution varied. While monthly recurring revenue (MRR) continued to increase, the pace of it seemed to slow.

This was primarily driven by softer gross adds in ports (due to consolidation in port sizes by customers and slowing sales momentum), while services continued to increase and so did MRR. Additionally, the company flagged that its indirect sales channel effort was not firing as quickly as it expected.

Aware of these issues, Megaport has addressed them head-on, focusing on costs, operational efficiencies and the value proposition to their customers.

The initial results of these efforts have been positive, as the company has moved into self-funding mode with EBITDA and free cash flow positivity being reached. In the most recent quarterly announcement, Megaport upgraded EBITDA guidance for the full year 2023 to $19-21 million from $16-18 million.

Recommendation

Our process is focused on finding those companies that are able to expand their economic footprint reliably over time. MP1 has executed extremely well since we invested in the company.

Save for the recent slip, the company has taken its revenue from roughly $20 million to $160 million and EBITDA from roughly -$20 million to $20 million in the last five years. We expect that it will continue over the next five as the company continues to scale across the profit and loss statement (P&L). Buy.

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