Flying Under the Radar: Innovative Solutions and Support’s Undervalued Growth Potential
Huge growth potential at a great price.
Investment Report
NASDAQ: ISSC
Market capitalization:116.2M
Stock price: 6.64
P/E ratio: 17.96
Div yield:
Key points:
Autonomous flight opportunity: Positioned to capitalize on the booming autonomous flight market.
Strong growth potential: Double-digit organic revenue growth with acquisition opportunities.
Solid client base: Contracts with blue-chip clients like Boeing, Pilatus, and Textron ensure steady, recurring revenue streams.
Low market capitalization: ISSC’s low market cap and cyclical industry exposure offer high potential returns for risk-tolerant investors.
1. Introduction:
Founded in 1988, Innovative Solutions and Support (ISSC) is a specialized systems integrator and manufacturer in the avionics industry, designing and producing advanced cockpit systems for both commercial and military aircraft. Initially led by founder Geoffrey S. M. Hendrick, a prominent figure in avionics who held nearly 100 patents, ISSC quickly became a key player in the industry. Under Hendrick's leadership, the company capitalized on regulatory changes like Reduced Vertical Separation Minimums (RVSM), leading to a surge in demand for its air data systems and driving revenues to a peak of $63 million in 2006. Over time, ISSC shifted its focus to flat panel display retrofits for older aircraft, establishing a niche position in cockpit avionics. The company has evolved with time developing products that were demanded by the market, with their current product offering they will be able to capitalize on aviation trends such as autonomous flight.
ISSC's earnings bottomed in 2018, as the company faced challenges in turning around its operations. A significant portion of their revenue, over 20%, came from engineering development contracts, which were burdened with razor-thin margins. Compounding this, the company had to dedicate substantial resources to research and development (R&D), when including internal R&D expenses the number approached 40% of total revenues.
After Hendrick's passing in 2022, Shahram Askarpour, the former President of Engineering, took the helm as CEO. ISSC has successfully turned around its operations after divesting from almost all their engineering development contracts, improving margins and achieving a revenue compound annual growth rate (CAGR) of over 20% since 2018. Management remains optimistic about the company's future, confident in its ability to sustain double-digit organic growth. Several catalysts, including the complete sale of shares from the late CEO's trust, new contracts, and increased investor interest, are poised to significantly boost ISSC’s stock price.
Despite not providing formal guidance, ISSC’s leadership has expressed their expectation to grow revenues beyond the $100 million mark in the future. The company is even preparing for expansion by considering the construction of a new manufacturing facility. With its strong foundation, history of innovation, and strategic leadership, ISSC is well-positioned for continued growth and success in the avionics sector.
2. Business segments:
Innovative Solutions and Support (ISSC) operates across three primary business segments: Product Sales, Customer Service, and Engineering Development Contracts. Each segment plays a crucial role in generating revenue and driving the company's growth.
1. Product Sales:
This segment encompasses the sale of equipment to a variety of customers, including OEMs, commercial air transport carriers, aviation companies, and government agencies such as the Department of Defense (DoD). While historically dominated by flat panel display systems (FPDS), this category also includes other key offerings like autothrottles and utility management systems (UMS). ISSC continues to secure significant contracts with OEMs such as Pilatus for UMS, Textron for autothrottles and standby instruments, and Boeing for the KC-46 and T-7 platforms. The stable revenue and margins from these large contracts form a critical part of the company’s overall business, and ISSC is increasingly expanding its presence in the military sector. A recent multi-million-dollar contract for a foreign military platform further underscores the company’s growth in this market.
I am not an expert in aeronautics so I leave you here a product brochure in case someone wants to take a deeper look on how these products work:
https://innovative-ss.com/wp-content/uploads/2023/11/Innovation_aerospace_2023rev10.pdf
In their website they also have all their current patents posted so I leave a link to that too:
https://innovative-ss.com/innovative-solutions-support/iss-patent-portfolio/
Revenue growth:
2024 product sales will be slightly down as the cargo market has been quite challenging this year, we could see some upside as some of the revenues from the military contract will start to be recognized in Q4.
They have a strong product portfolio protected by patents and certifications that allow them to operate successfully in their market, additionally they spend a lot of money on internal R&D (10% of revenues), so they are a technology leader in their niche.
2. Customer Service:
ISSC provides maintenance, repair, and upgrade services to its customers through either field service engineers or its in-house repair facilities. This segment has experienced notable growth, particularly following the acquisition of product lines from Honeywell. The addition of these service-driven sales has enhanced both revenues and profitability in this area, as ISSC supports its customers with the necessary expertise to maintain and optimize their avionics systems.
2024 customer service sales will be around 20 million dollars as we will see the full effect of HoneyWell acquisition.
3. Engineering Development Contracts:
ISSC earns revenue from engineering development contracts when customers require customized systems, such as flat panel display solutions (FPDS) tailored to meet specific requirements. These revenues are usually really low margin and fortunately the group has less than 4% of their revenues coming from this segment.
3. Sector diversification:
The company’s revenues are diversified across three main aviation sectors: military, general aviation, and commercial air transport (cargo). Management is aware of the cyclical nature of these sectors and strategically leverages this diversification. On the last earnings call the CEO said that: when one market, such as cargo, experiences a slowdown, as has been the case this year, the company shifts focus to its other segments. For example, as part of its effort to grow the military segment, ISSC hired a retired veteran to help sell some of their products. This uncommon strategy appears to have paid off, as the company has since secured several notable military contracts.
Currently, 44% of ISSC’s revenues come from the commercial air transport segment, which has been significantly lower this year. Both the military and general aviation segments now represent nearly equal portions of the company’s revenue mix. Looking ahead, I expect the military segment to represent a higher percentage of overall revenues as the company begins recognizing income from its recently awarded contract.
4. Honey Well acquisition:
The acquisition of Honeywell's product lines marks a pivotal moment in Innovative Solutions and Support (ISSC)'s growth strategy, presenting significant opportunities to capitalize on underutilized production capacity, broaden its market reach, and enhance profitability.
Prior to the acquisition, ISSC’s production facility was operating at just 30% capacity, indicating substantial room for growth without the need for heavy capital expenditures. The increased utilization of the facility should lead to greater economies of scale, improving gross margins over time. This operational efficiency is likely to result in a highly favorable impact on ISSC’s profitability. We have been seeing this during 2024, with gross margins improving year over year, and management expects this trend to continue in 2025.
The CEO, in the third-quarter earnings call of 2023, outlined the strategic rationale behind the acquisition. By licensing several product lines from Honeywell Aerospace, ISSC significantly expanded its product portfolio, particularly in the air transport and business aviation markets, with potential expansion into military platforms. This acquisition was expected to boost the company’s annual revenue by 40%, with an even greater impact on earnings. EBITDA was projected to grow by approximately 75% once operations were fully integrated by 2024. Additionally, the CEO emphasized the company’s ability to better leverage its infrastructure, sustain high margins, and deliver accretive earnings starting in 2024.
One year after these expectations were set, the CEO reflected on the success of the acquisition. Over the trailing 12 months, ISSC achieved a 54% increase in consolidated revenue, 75% growth in adjusted EBITDA, and a 28% rise in EPS, exceeding the original projections. Despite some inefficiencies, the company performed well in integrating these new assets while pursuing other growth initiatives. Moreover, the acquisition opened doors to new customer relationships, particularly in international markets where ISSC previously had limited presence.
Historically, these product lines generated $21.5 million in revenue and produced $11.1 million in gross profits, yielding an impressive 51.6% gross margin. The pre-tax income (PBT) generated from these products was $9.55 million, according to the company. Given that ISSC paid a mere 3.8x multiple on this acquisition, it is considered an exceptional bargain, especially in a market where such valuations are rare. Honeywell, a company with a $135 billion market cap, divested these non-core assets to focus on next-generation avionics. The seller’s price insensitivity, combined with a focus on finding a buyer that would not disrupt customer relationships, made ISSC the ideal acquirer. The fact that there were seven bidders for these product lines further validates the quality of the assets ISSC acquired. It is highly unlikely that ISSC ended up purchasing underperforming product lines, particularly considering the strong competitive interest. This, combined with ISSC’s strong post-acquisition performance, reinforces the soundness of the deal.
The deal primarily consisted of a $13 million acquisition of inventory and equipment, with the remainder allocated mainly to goodwill and intangible assets. Although ISSC did not technically purchase the product lines, they received licensing rights to these products indefinitely, making the deal comparable to an acquisition. In addition, the company can use the Honeywell brand when selling or offering technical services related to the licensed product lines, which adds significant market credibility.
ISSC also gained new client relationships through this transaction, which they can leverage. These new clients could benefit from ISSC’s existing products, while some of their old clients may find value in the newly licensed product lines. The ability to cross-sell between these customer groups enhances the value of the acquisition.
The company further built on its success by acquiring additional communication and navigation radio product lines from Honeywell. While smaller in scale, this second acquisition strengthens ISSC’s offerings in military and business aviation markets, further leveraging the underutilized capacity at their Exton facility.
Financially, ISSC has improved markedly post-acquisition. The company financed part of the deal with debt, initially raising its leverage to 2.9x. However, through aggressive debt repayment, ISSC has reduced its debt burden to just $9.3 million, lowering leverage to a manageable 0.8x. This financial discipline not only reduces risk but also positions ISSC for further growth opportunities.
Management has expressed confidence in sustaining double-digit organic revenue growth in the coming years, signaling that these product lines have considerable room for expansion. The addition of inventory from both acquisitions further boosts the accretive nature of these deals, as ISSC can sell or lease the inventory, enhancing cash flow and profitability.
5. Competitive advantages:
Innovative Solutions and Support (ISSC) holds several key competitive advantages that position it strongly in its niche market:
Patent Protection: ISSC has a portfolio of patents, some maturing in 2026-2027, with new patents in the pipeline, ensuring continued protection of its intellectual property and innovations.
Niche Market, Limited Competition: Operating in a specialized segment of the aviation industry, ISSC faces limited competition, allowing it to dominate key markets with highly tailored solutions. This is clearly shown with their margins, GM have been around 50-60%. This year nearer to 50% principally due to some inefficiencies with their Honeywell acquisition which are expected to be solved by next year. These margins are protected as new entrants will need to spend a good amount of money in R&D and wait for the FAA approval before entering the market.
Blue-Chip Clients: ISSC serves top-tier clients like Pilatus, Boeing, and Textron, securing long-term relationships and reliable revenue through stable contracts. This provide them with a strong moat as having a close relationship with the biggest players in the industry gains them an edge against new entrants which will find difficult to build relationships with these clients.
Long-Term Contracts: ISSC benefits from multi-year agreements with clients, providing consistent revenue and reducing competitive threats, stable revenues allow them to invest in R&D and therefore continue leading their niche market.
6. Major clients:
Innovative Solutions and Support (ISSC) has secured a number of high-profile blue-chip clients, many of which are industry leaders worth billions of dollars. Currently, ISSC has four key OEM production contracts, demonstrating its focus on creating stable, recurring revenue streams.
Boeing T-7A Red Hawk Trainer Program – Awarded in 2023, ISSC supplies GPS sensor units for the Boeing T-7A Red Hawk, an aircraft designed for pilot training.
Boeing KC-46A Tanker Program – Since 2011, ISSC has provided Aerial Refueling Operator Control and Display Units for Boeing’s KC-46A tanker. The U.S. Air Force plans to procure 179 tankers by 2027, with deliveries continuing through 2029.
Pilatus PC-24 – ISSC’s Utilities Management System (UMS) has been standard equipment on every Pilatus PC-24 since 2013 under a multi-year production contract.
Textron King Air 260 and 360 – Under a multi-year agreement, ISSC provides its ThrustSense Autothrottle system for Textron’s King Air 360 and 260. The system became standard on the King Air 360 in 2020 and on the King Air 260 in 2021. This contract is expected to drive significant revenue in the coming years, especially as the U.S. Navy has enlisted the Textron King Air 260 for training pilots in various military roles.
In addition, ISSC recently signed a multi-million-dollar agreement with an undisclosed military company, further expanding its portfolio of high-value clients.
7. Leadership:
Shahram Askarpour serves as the Chief Executive Officer of Innovative Solutions and Support (ISSC), bringing over 40 years of aerospace industry experience. He joined the company in 2003 as Vice President of Engineering and was promoted to President in 2012, before assuming the role of CEO following the passing of the company’s founder, Geoffrey S. M. Hendrick, in 2022. Dr. Askarpour has been a key player in shaping ISSC’s leadership, strategy, and technological advancements. Prior to joining ISSC, he held senior positions at Smiths Aerospace, Instrumentation Technology, and Marconi Avionics, and he holds several key patents in the aviation field.
Dr. Askarpour’s deep commitment to ISSC is further demonstrated by his significant ownership stake of 2.71% in the company, aligning his interests closely with those of shareholders. This substantial insider ownership reinforces his confidence in the long-term potential of ISSC, making him both a leader and a key investor in the company’s future.
Following the death of the founder and former CEO, Geoffrey S. M. Hendrick, in 2022, his trust—which initially held a large portion of ISSC’s shares—has been steadily selling off its stake. This has contributed to downward pressure on the stock price over the past year. Currently, the trust holds only 5.1% of the company, significantly reducing its impact on future stock movements. The alleviation of this selling pressure positions ISSC for a more stable and potentially upward trajectory in the market, as investor sentiment can now focus more on the company’s performance and growth prospects under Askarpour’s leadership.
8. Takeover attempt:
In May 2024, investor Christopher Harborne, who holds 15.1% of ISSC, made a bid to take the company private through a proposal to acquire all outstanding shares he did not already own. Offering $7.25 per share in cash, Harborne’s proposal represented a 45% premium over the company’s closing price on May 23, 2024. Harborne, an experienced investor and CEO of Sherriff Global Group, emphasized his belief in the company’s long-term potential as a leader in the aviation and aerospace industries. However, he expressed concerns that ISSC, as a public company, was not best positioned to reach its full potential. Harborne argued that privatizing the company would better align it for long-term success while providing shareholders with immediate, attractive cash value for their shares.
He pointed out several risks inherent in ISSC’s current structure as a small public company, including limited access to capital markets, low trading liquidity, and the potential market overhang from shareholders seeking to sell. Harborne viewed privatization as a way to mitigate these risks and focus on maximizing long-term value without the pressures of public ownership. His proposal, while non-binding and contingent on due diligence, outlined his commitment to negotiating mutually acceptable terms with the board and expressed confidence in completing the deal quickly due to his familiarity with the company.
However, after careful consideration and consultation with financial and legal advisors, the Board of Directors unanimously rejected the offer. They asserted that the proposal significantly undervalued ISSC and lacked the certainty needed to proceed. The Board remained confident that the company’s long-term strategic plan, driven by its current management, would deliver superior value to shareholders and stakeholders. They reaffirmed their belief that ISSC’s ongoing execution of its strategy would generate more substantial returns than the proposed acquisition.
Christopher Harborne appears to be a growth investor, as he is the director of a blockchain research organization. He may be seeing something in the company’s products and their potential to capitalize on the autonomous flight market that others do not. While it’s highly speculative, the possibility that he made the acquisition offer knowing the board would reject it, perhaps to draw analysts' attention to the stock, should still be considered.
9. Order backlog:
As of June 30, 2024, ISSC reported a backlog of $9.3 million. It is important to note that the backlog figure includes only confirmed purchase orders in hand and excludes long-term commitments from key OEM customers such as Pilatus PC-24, Textron King Air, Boeing T7 Red Hawk, and Boeing KC-46A. These long-term programs are expected to remain in production for several years, continuing to generate future sales for ISSC. Due to their extended nature, these programs are not reflected in the current backlog numbers, providing additional long-term revenue visibility that is not captured in the immediate figures.
Moreover, the product lines acquired from Honeywell typically do not enter backlog due to their unique nature, making it normal for the backlog to remain relatively stable year over year.
In addition to the existing backlog, ISSC recently announced that they had secured a multi-million-dollar contract with a major aerospace partner, which has not yet been included in the reported backlog. This contract is expected to be disclosed in the following quarter, which will likely result in a significant backlog increase.
10. Autonomous Flight:
Autonomous flight presents a significant opportunity for ISSC, as this market is projected to grow rapidly over the next decade and is expected to be worth billions. The company has a clear strategy in place to capitalize on this emerging billion-dollar industry.
According to ISSC's May 2024 investor presentation, the success of air mobility at full scale will depend on autonomous flight, as it offers a solution to long-term pilot shortages. Major industry players are already investing heavily in this area.
In the near future, ISSC plans to develop a product integrated with its Eclipse Display system, which will be capable of taking over key co-pilot tasks. This product is expected to be highly marketable, offering an attractive return on investment (ROI) for both operators and OEMs.
Looking further ahead, the company aims to create a fully certified autonomous flight control system, guided remotely from the ground, which will eventually replace both the pilot and co-pilot—eliminating the need for cockpit crew altogether.
ISSC already has two key products that incorporate much of the technology required for optionally piloted autonomous flight. Their strategy is to combine these technologies and apply them to large, commercially operated aircraft.
If the company successfully develops a FAA certificated technology for autonomous flight, they will have a huge increase in revenues and profits. Because I do not know how this could materialize in the future and no guidance has been given I would not include this in my base case valuation.
11. Growth opportunities:
Innovative Solutions and Support (ISSC) is well-positioned for sustained growth across several strategic areas, as outlined by the CEO in the Q3 2024 earnings call. The company’s long-term growth strategy focuses on five key initiatives: expanding existing platforms, developing new OEM and retrofit programs, growing their pipeline of opportunities, entering new markets, and pursuing strategic acquisitions.
1. Expansion of Existing Platforms:
ISSC’s current platforms offer significant, predictable growth opportunities driven by the scheduled expansion of key customer programs. One notable example is the Pilatus PC-24 aircraft, which continues to generate growth for ISSC as production increases. These long-term contracts with established OEMs provide ISSC with steady revenue streams that they can use for acquisitions or R&D.
2. New OEM and Retrofit Programs:
Leveraging its history of innovation, ISSC is focusing on new OEM and retrofit programs as major drivers of future growth. These programs offer more stable and predictable revenue compared to other business lines, especially through deep customer relationships. The company’s acquisition of Honeywell product lines has strengthened these relationships, enabling cross-selling opportunities with key clients. For instance, ISSC has successfully integrated newly acquired Honeywell radio products with its cockpit offerings on platforms such as the C-130, further enhancing its product portfolio and opening up new revenue streams.
3. New Market Opportunities:
ISSC is actively targeting new market opportunities, particularly in the military sector, which remains underpenetrated for the company but presents a tremendous long-term growth potential. With several of ISSC’s products well-suited for military applications, the company is poised to capitalize on this multi-billion-dollar addressable market. In addition, ISSC is investing heavily in cockpit automation, a sector expected to grow significantly over the next few years. This technology enhances safety and reduces pilot workload, and ISSC’s developments in this space are expected to generate incremental revenues in both military and air transport applications.
4. Strategic Acquisitions:
ISSC’s acquisition strategy is a key pillar of its growth plan. With a strong cash flow and financial profile, ISSC is well-positioned to pursue acquisitions that complement its existing business. The company’s focus is on product lines in the electronic and electromechanical space with similar margin profiles, which allow ISSC to leverage its manufacturing capacity and enhance profitability. This acquisition-driven growth, as seen with the successful integration of Honeywell’s product lines, is expected to continue contributing to ISSC’s revenue and margin expansion.
5. Infrastructure Expansion:
In anticipation of potential future growth, ISSC is considering the construction of a new 40,000-square-foot factory to support its goal of surpassing $100 million in revenue within the next few years. While the CEO expressed optimism during an earnings call, indicating confidence in the company’s ability to reach this milestone, it remains speculative at this stage. If achieved, this revenue target could result in significant stock price appreciation.
6. R&D and Margin Expansion:
ISSC’s investment in research and development (R&D), representing 9.3% of total sales last quarter, is another critical driver of future growth. The company is focused on developing next-generation technologies, such as its flight control computer for the Pilatus PC-24 aircraft, which will provide a steady stream of revenue for decades. While R&D expenses have been elevated recently, management expects these costs to decrease over time as the company benefits from scale. Furthermore, ISSC is targeting margin expansion, pro-forma margins for this year 2024 are between 56-57% with some additional improvements that are expected for 2025 and will increase margins.
7. Growing Backlog and New Contracts:
ISSC’s backlog remains steady at $9.3 million, but the company recently announced a multi-million-dollar contract with a major aerospace partner, which will be disclosed in the next quarter. This contract, lasting 2-3 years, will contribute significantly to the company’s revenue pipeline and further strengthen its backlog position.
In conclusion, ISSC’s growth opportunities are broad and diverse. With strong existing platforms, strategic expansions into new markets, a commitment to innovation, and a clear focus on both organic and acquisition-driven growth, the company is well-positioned for continued success. As ISSC executes on its strategy, it is expected to achieve double-digit organic growth and further capitalize on its expanding market opportunities.
12. Thesis:
Innovative Solutions and Support (ISSC) is well-positioned for future growth, but the realization of significant share price appreciation will likely depend on several potential catalysts that could unfold in the coming years.
1. Reduced Overhang from Founder’s Trust:
With the late founder Geoffrey S. M. Hendrick’s trust now holding just 5.1% of the company’s shares after selling most of its stake, the prior selling pressure has largely diminished. As this trust continues to reduce its holdings, the stock could experience less selling pressure, allowing ISSC’s share price to better reflect its operational performance and growth prospects.
2. Increased Institutional Interest:
As ISSC continues to expand and demonstrate strong profitability, institutional investors may begin to take greater interest in the stock. As the company grows larger and more profitable, it could attract institutional buyers who were previously hesitant due to its smaller size. This increased demand could significantly drive up the share price over time.
3. Potential Share Buy-Back Program:
The introduction of a share buy-back program could be a powerful catalyst for future share price growth. Should ISSC’s management initiate such a program, it would signal confidence in the company’s long-term prospects and reduce the number of outstanding shares, which could lead to higher earnings per share (EPS) and a corresponding rise in the stock price.
4. Acquisition Potential:
Given ISSC’s solid financials, niche market position, and valuable client relationships, it may become an attractive target for acquisition. Any acquisition offer would likely come with a premium, providing immediate value to shareholders. If ISSC is approached for a buyout in the future, it could serve as a significant catalyst for share price appreciation.
13. Valuation:
For FY 2024, I have forecasted that ISSC will close its final quarter with a 10% increase in revenue, reflecting the company’s steady growth. However, I anticipate a slight decrease in margins compared to the previous quarter. It’s important to note that I have not included any proforma adjustments for one-time events, which, if accounted for, would increase margins by 350 basis points, as indicated by the CEO in the most recent earnings call.
Moving forward, we will explore three potential scenarios: base, bull, and bear. To assess how ISSC might perform over the coming years.
Base Case:
In the base case, I assume ISSC will continue to experience double-digit growth over the next five years, consistent with its recent performance. Management is expected to gradually restore margins to pre-acquisition levels, a conservative assumption given that integration of acquisitions could lead to additional cost synergies. Additionally, research and development (R&D) expenses are forecasted to decline as a percentage of revenues as the company benefits from economies of scale. Under this scenario, ISSC is projected to reach close to $100 million in revenue by 2029, a target that seems realistic given the company's multiple growth drivers.
Base Case Assumptions:
Revenue Growth: Double-digit CAGR over the next five years.
Margins: Gradual improvement to pre-acquisition levels, with potential for synergies.
R&D Expenses: Decline as a percentage of revenues due to economies of scale.
Bull Case:
In the bullish scenario, ISSC successfully develops and capitalizes on its autonomous flight products, entering this rapidly growing market and achieving a 25% compound annual growth rate (CAGR) after 2027. The company’s ability to integrate these products with its existing offerings (such as the Eclipse Display system) would provide a competitive edge, allowing ISSC to gain significant market share. In this scenario, ISSC becomes a key player in the emerging autonomous flight industry, which is expected to be worth billions in the next decade.
Bull Case Assumptions:
Revenue Growth: 25% CAGR after 2027, driven by success in the autonomous flight market.
New Market Entry: ISSC capitalizes on autonomous flight opportunities and scales successfully.
Bear Case:
In the bearish scenario, ISSC faces challenges in realizing cost synergies from its acquisitions and struggles with product adoption. Growth is limited to 10% annually, as the company fails to fully capitalize on its growth opportunities. Margins also fail to recover, remaining below expectations due to ongoing integration challenges and competitive pressures. In this case, ISSC remains a niche player with limited growth in market share.
Bear Case Assumptions:
Revenue Growth: 10% annual growth due to weak market performance.
Margins: No significant improvement due to difficulties with acquisitions and product adoption.
Key Valuation Considerations:
Acquisition Potential:
One factor to consider in the valuation of ISSC is the potential for it to become an acquisition target. The avionics market is becoming increasingly important, and valuations in the sector have risen in recent years. An acquisition would likely require a significant premium, especially given that the board previously rejected a 45% premium offer from the CEO. A potential acquirer would need to offer a premium of at least 75%, given ISSC’s improved business prospects.
Historical Valuation Multiples:
ISSC has historically traded at high valuation multiples, including EBIT multiples in the high teens and P/E ratios in the 20s. Assuming margins normalize by 2024, we can expect ISSC to return to these valuation ranges, particularly if growth accelerates and profitability improves as forecasted.
Final Valuation:
Bull Case: If ISSC successfully enters the autonomous flight market and achieves rapid growth, the company could be valued significantly higher, with the share price potentially more than tripling from current levels.
Base Case: In the most likely scenario, where ISSC continues to grow at a double-digit rate and improves margins, the stock could see significant upside, driven by increased revenue and profitability, reaching a higher valuation as revenues approach $100 million by 2029.
Bear Case: If the company struggles with growth and margin expansion, the stock may remain volatile, with limited upside, potentially leading to only modest price appreciation over the next few years.
Each scenario reflects the different potential paths ISSC could take, with the base case being the most realistic, while the bullish and bearish scenarios offer insights into the upside and downside risks.
As you can clearly see the company offers great return potential in the bull and base case while the bear case would certainly underperform the market by a wide margin.
14. Risks:
While Innovative Solutions and Support (ISSC) offers substantial growth potential, there are several risks that investors should carefully consider:
1. Margin Improvement Challenges:
A key risk is the possibility that management may not succeed in improving margins as expected in 2025. If ISSC fails to execute its margin expansion plans, it could negatively impact profitability and investor sentiment.
2. Limited Analyst Coverage:
ISSC has relatively low visibility in the market, with few analysts covering the stock. Without increased interest from analysts and institutions, the stock could remain under the radar for an extended period, potentially limiting its price appreciation despite the company's solid fundamentals.
3. Takeover Risk in a Downturn:
During an economic downturn, liquidity concerns could push the board to accept a lower-priced acquisition offer, especially if a takeover attempt occurs. This scenario could lead to shareholders missing out on the long-term gains they might have achieved by holding the stock.
4. Volatility Due to Low Capitalization and Cyclicality:
With its low market capitalization, ISSC's stock is more susceptible to volatility. Additionally, the company operates in a cyclical market, which can lead to significant short-term fluctuations in stock price. Investors should be prepared for heightened volatility, especially during periods of economic uncertainty or sector-specific downturns.
These risks highlight the need for careful consideration and monitoring of ISSC’s performance, particularly as it navigates potential challenges in margin improvement, market visibility, and cyclical volatility.
15. Conclusion:
In my view, Innovative Solutions and Support (ISSC) is a solid business with a clear path to growth. Although the company has been undervalued for some time and may continue to fly under the radar for a little longer, the catalysts we’ve discussed could prompt the market to finally recognize its true potential. The emerging autonomous flight market represents a massive opportunity, and if ISSC can capitalize on it, the upside could be substantial.
For patient investors willing to hold for the next few years, ISSC offers a unique opportunity. While the stock may not deliver overnight returns, its strong fundamentals, strategic positioning, and leadership's confidence make it a promising investment for those looking toward the long-term horizon.
When I think about investment opportunities, I always ask myself: Why am I able to invest in this opportunity while others do not? In a recent article, I explored the competitive advantages we have as investors. In ISSC's case, I am leveraging two key advantages:
Time:
Time refers to your investment horizon, how long you're willing to wait to achieve your desired returns. Many institutional investors are pressured by short-term performance metrics and can’t afford to wait, but as individual investors, we have the flexibility to hold positions for the long term. This gives us an edge, especially with companies like ISSC that are in the process of growth or turnaround. However, this patience must be real, if you're not prepared to endure the volatility along the way, you’ll miss out on the long-term rewards.Assets Under Management:
Managing smaller amounts of capital gives individual investors a unique advantage. Larger funds are restricted from investing in small-cap companies like ISSC because they don’t move the needle for their portfolios. As Warren Buffett famously said, he could compound capital at 50%+ if he were managing smaller amounts. If you're managing less than $5 million, small caps can provide excellent opportunities that are simply uninvestable for big institutions.
These two advantages make ISSC an appealing investment for those willing to take a long-term view and capitalize on opportunities overlooked by larger investors.
Disclaimer:
The information provided in this article is for informational purposes only and should not be considered financial advice. The content does not constitute a recommendation to buy, sell, or hold any security or investment. Always do your own research and consult with a professional financial advisor before making any investment decisions. Investing in stocks involves risk, including the potential loss of principal. Past performance is not indicative of future results.