Aviat Networks, the global microwave networking solutions provider, has always been a company of subtle moves, quietly building its empire in the background. But their recent acquisition of NEC Wireless Transport, now dubbed the "Pasolink business," may be their most masterful play yet, and one that seems to be flying under the radar of Wall Street analysts. While everyone is focused on the hardware aspect of the deal, there's a hidden gem within this acquisition: software. And it could be the key to unlocking a level of profitability that goes far beyond initial expectations.

On the surface, the Pasolink acquisition looks like a smart, strategic move to expand Aviat's global footprint and hardware portfolio. And it is. But dig a little deeper and you'll find evidence of a much grander plan. Aviat isn't just buying hardware, they're buying an entry point into a loyal customer base hungry for advanced software solutions.

The clues are scattered throughout the Q2 and Q3 2024 earnings call transcripts. Notice the emphasis placed on customer engagement and excitement surrounding the integration of Aviat's ProVision Plus network management software with Pasolink products. This isn't just a nice bonus for existing customers; it's a calculated move to leverage Aviat's proven software expertise and establish a dominant position in the market.

"Consider these statements from CEO Pete Smith during the Q2 2024 Earnings Call [1]: "Our plans to integrate our network management software, ProVision Plus with Pasolink products will deliver improved functionality and ease of use to Pasolink customers. This is a request we've heard from many customers and we are excited to deliver for them. This software will serve as a platform for product portfolio convergence in the years ahead.""

Further evidence surfaces in the Q3 2024 Earnings Call transcript [2], where Smith highlights the enthusiasm for integrating software solutions like FAS (Frequency Assurance Software) and HAS (Health Assurance Software) into the Pasolink ecosystem:

"“This doesn't show up in the financials but we're enthused about the customer engagement and the desire for us to make things like FAS and HAS and our network management software work on the Pasolink radios.”"

The enthusiasm isn't just anecdotal. Aviat's core business already boasts impressive numbers, with a 14.5% adjusted EBITDA margin in Q2, a significant jump from the 0.6% margin just 16 quarters ago. This speaks volumes about the effectiveness of Aviat's operating model and their ability to drive profitability through software innovation.

The potential for revenue synergy through software sales is huge. While Aviat hasn't quantified these synergies, their excitement about the prospects is palpable. They've specifically called out international markets, particularly Tier 1 customers in regions outside the U.S., as prime targets for software adoption.

But the software play goes even deeper. By integrating ProVision Plus with Pasolink products, Aviat lays the groundwork for future hardware convergence. While this is a longer-term goal, expected in the third year of ownership, it further reinforces the idea that Aviat is thinking far beyond the immediate hardware gains of the acquisition.

Projected Pasolink Business Performance

Aviat projects the Pasolink business to reach the following financial targets:

Source: Aviat Networks Q2 2024 Earnings Call [1]

These are already solid targets, but the potential for software to accelerate this timeline and drive margins even higher is significant. Let's look at Aviat's core business performance. Their software-driven growth has already propelled them to a 38% gross margin year-to-date in FY 2024, a full 200 basis points ahead of their initial guidance. While they expect a modest pullback in Q4, this performance establishes a new baseline and showcases the potential for software to drive margin expansion.

Gross Margin Comparison: Core Aviat vs. Pasolink

The chart below highlights the potential for software-driven margin improvement in the Pasolink business.

If Aviat can replicate even a portion of their core software success with the Pasolink customer base, the potential for exceeding their initial 33% gross margin target and accelerating their profitability timeline becomes highly probable.

Furthermore, the anticipated reduction in Pasolink's inventory levels, estimated at a third of current levels, will release substantial cash flow, further bolstering Aviat's financial position and providing additional resources for software development and customer engagement. [1]

While Wall Street is focused on the hardware numbers, Aviat is quietly building a software powerhouse within the Pasolink business. The potential for revenue synergies, accelerated profitability, and long-term hardware convergence makes this acquisition a hidden treasure, one that could propel Aviat Networks to new heights of financial success.

"Fun Fact: Microwave backhaul technology, Aviat's core competency, is used not just in telecommunications, but also in diverse fields such as broadcasting, transportation, and even space exploration! For example, NASA uses microwave links to transmit data from spacecraft to ground stations."