redflex versus adacel, page-3

Hi Prime,

The two companies certainly have important differences, but are perhaps more similar than you think. You point to the fact that RDF deserves a higher earnings multiple than Adacel because the photo enforcement market is only 5% penetrated and that RDF holds a 50% market share in the USA.

Well, Adacel's key market – the ATC sim market using new voice recognition technology – is only around 10% penetrated, and Adacel has around 80% market share in the USA (the largest market in the world).

The basic business models of the two companies are also similar: both companies are receiving up-front revenue rolling out their respective products (photo enforcement products, ATC simulators), and both companies also receive long term, high-margin 'annuity' type revenue (in the case of RDF, fixed monthly fees or fees per citation; in the case of ADA, maintenance, support, and simulator staffing fees). The larger the installed base of cameras/simulators, the larger the annuity revenue.

As I said in my last post, I think RDF is deserving of its high PE. My point is that many of the elements of RDF's business that make it such an attractive investment are also shared by Adacel (ADA). And given that Adacel is currently trading on a very low earnings multiple (forward PE of just 7.5), I think the stock is probably primed for a significant re-rating.

To put it another way, it is hard to see any justification for RDF doubling in price over the next 6 months, but easily to see such justification for Adacel.