We lower our fair value estimate for no-moat Megaport MP1 by 16% to $10.50 per share. Management reaffirmed guidance for fiscal 2025, which we expected it to beat, and guided for fiscal 2026 to have a similar growth trajectory.

Megaport is one of the world’s largest software-defined network service providers, enabling over 2,800 enterprise customers to connect to over 800 data centers in over 150 cities throughout the world. Megaport’s services mostly revolve around enabling enterprises to connect to cloud service providers, like Amazon Web Services, but it also offers services to enable businesses to connect across multiple data centers and to internet exchanges.

The update indicates to us that the company has significantly overestimated its pricing power in recent years and now appears to be in an uncompetitive position. We have updated our models to incorporate our evolved understanding of Megaport’s market position and now assume less growth and higher costs.

To address the pricing issue, the company is now ramping up hiring in its sales and marketing team, including by headhunting sales talent from competitors. We see the logic behind the move but are unsure about how much sales effort will now be required to sell an overpriced commodity product.

Based on these missteps, we also lower our Morningstar Capital Allocation Rating to Poor from Exemplary. Although the company has pursued an aggressive land grab in the past, which we viewed as the correct strategy, the company now finds itself in a position where it either needs to lower its prices again, expend significantly more resources to achieve continued growth, or hope for competitors to raise prices.

We believe shares continue to screen as undervalued. Recent layoffs at a significant competitor, despite Megaport’s pricing mistakes, reaffirms for us that this is a tough industry to operate in. Given Megaport’s superior scale, we expect the company to be able to deliver the commodity product at a lower cost than competitors. We expect this dynamic to eventually lead to an industry shakeout, leaving Megaport as the winner.

Business strategy and outlook

We expect Megaport's strategy in the near term will revolve around navigating significant pricing mistakes it made in early 2023, which have put its products in an uncompetitive position. Our assessment of Megaport's products are that they are commodities, leaving price as the key deciding variable. Given recent price hikes made its products too expensive, compared with alternatives, the company now finds itself in a position where it either needs to revert recent prices hikes, which would lower revenue again while still leaving existing customers aggravated over the memory of the price hike, expend significantly more resources to sell its overpriced products or hope for competitors to raise prices as well.

In the long term, we expect the industry to shake out, leaving Megaport as the winner.

Capital allocation rating

Megaport has an Poor Capital Allocation Rating, reflecting our assessment of a sound balance sheet, poor investment efficacy, and appropriate shareholder distributions.

Megaport’s balance sheet is sound. As of the end of June 2024, Megaport was in a significant net cash position, and we forecast positive free cash flows from fiscal 2024.

We rate investment efficacy as poor. Since its creation in 2013, Megaport invested heavily to achieve widespread network coverage and density and to offer connectivity services to an increasing share of the largest CSPs. We believe this aggressive land grab has allowed Megaport to become one of the few SDNs of sufficient scale and has set it up to enjoy years of high growth as customers move an increasing share of their demand for connectivity services to Megaport. However, recent pricing miscalculations risk reversing these benefits gained.

Megaport currently does not return capital to shareholders, which we view as appropriate, given ample growth opportunities.

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Terms used in this article

Star Rating: Our one- to five-star ratings are guideposts to a broad audience and individuals must consider their own specific investment goals, risk tolerance, and several other factors. A five-star rating means our analysts think the current market price likely represents an excessively pessimistic outlook and that beyond fair risk-adjusted returns are likely over a long timeframe. A one-star rating means our analysts think the market is pricing in an excessively optimistic outlook, limiting upside potential and leaving the investor exposed to capital loss.

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Moat Rating: An economic moat is a structural feature that allows a firm to sustain excess profits over a long period. Companies with a narrow moat are those we believe are more likely than not to sustain excess returns for at least a decade. For wide-moat companies, we have high confidence that excess returns will persist for 10 years and are likely to persist at least 20 years. To learn about finding different sources of moat, read this article by Mark LaMonica.

Uncertainty Rating: Morningstar’s Uncertainty Rating is designed to capture the range of potential outcomes for a company. An investor can think of this as the underlying risk of the business. For higher risk businesses with wider ranges of potential outcomes an investor should consider a larger margin of safety or difference between the estimate of what a share is worth and how much an investor pays. This rating is used to assign the margin of safety required before investing, which in turn explicitly drives our stock star rating system. The Uncertainty Rating is aimed at identifying the confidence we should have in assigning a fair value estimate for a stock. Read more about business risk and margin of safety here.