nLIGHT: Founder-Led Laser Business, Expanding Into Defense Market

John Barr of Needham Funds presented his in-depth investment thesis on nLIGHT, Inc. (US: LASR) at Best Ideas 2024.

Thesis summary:

Established business growing, while investing in new business. nLIGHT has an industrial business that serves the welding, cutting, additive manufacturing and microfabrication markets. The company has been investing in its business since 2019 and has accumulated $161 million of losses. nLIGHT has also invested in the defense business with the acquisition of Nutronics, a new manufacturing facility in Camas, WA, which John believes has $1 billion of capacity and sales and marketing to diversify its revenue base away from China.

After years of research and development across industry and government, the laser industry has seen rapid progress over the last few years. Laser systems may be operationally deployed in the defense industry within the next five years, and nLIGHT could be one of a handful of suppliers.

Can the company be 5-10x its current size? nLIGHT serves the microfabrication, industrial and defense markets and the company estimates that in 2025, these markets will total $3 billion, including $1 billion from defense. In the last 12 months, nLIGHT had industrial and microfabrication revenue of $127 million, aerospace and defense revenue of $37 million, and government fiber laser defense contract revenue of $50 million. With 25% annual growth, the existing product business could achieve $500 million of revenue in five years. This business is lumpy based on economic activity.

The upside in nLIGHT comes if defense fiber laser systems see their first operational deployments. The U.S. DoD has a pressing need for fiber laser defense systems to combat the asymmetric threat from low-cost drones. In September 2023, Laura DeSimone, Executive Director, Missile Defense Agency (MDA) said, “However in recent months, the agency has seen ‘that technology maturation is happening,’ including at the US national laboratories, the Department of Energy and within industry.” If fiber lasers are ready for defense markets, they could be quickly adopted.

Purchase with a margin of safety. As of September 30, 2023, nLIGHT had $112 million of cash and no debt, other than $14 million of leases. John estimates nLIGHT will use less than $10 million of cash before turning EBITDA positive, which could leave $2.00 per share of cash. The cash cushion provides protection from a worst-case scenario.

The ultimate measure of safety comes from the profitability of the business. Wall Street estimates show nLIGHT with $42 million of net losses in 2023. John estimates that nLIGHT will reach breakeven in two to three years at approximately $350-400 million of revenue.

nLIGHT’s minimal reliance on China, along with its U.S. headquarters and manufacturing also provides a margin of safety. In 2016, 38% of nLIGHT’s revenue was from China. nLIGHT has invested to diversify its revenue base away from China and in 3Q23, revenue from China was down to 5%. nLIGHT is one of just a few companies with the expertise and capacity to meet the U.S. DoD requirements. As nLIGHT has pivoted its plans toward the U.S. DoD, it is imperative to have minimal presence in China.

Fiber laser peers in the defense sector, such as Lockheed Martin Corporation (LMT), RTX Corp. (RTX), Northrop Grumman Corp. (NOC), are much larger companies. These larger companies are not vertically integrated and are customers of nLIGHT’s semiconductor diodes business. IPG Photonics Corp. (IPG) is a peer in the industrial market, but has significant operations in Russia and Belarus, which hinder its ability to compete for U.S. defense business.

The final element of margin of safety comes from the valuation and John’s long-term earnings estimate. nLIGHT is valued at $13.50 per share with approximately $2.00 per share of cash. This $13.50 stock price reflects the outlook for the next 12 months. Since 2022, nLIGHT’s financials have shown gross margin in the low 20%s and declining revenue, as China revenues declined and low-margin fiber laser defense research and development contract revenue grew. Gross margin and net income are estimated to remain unremarkable until fiber laser defense product sales grow.

At some point in the next five years, we could see a substantial boost in the defense systems business, and nLIGHT could earn up to $2.50 per share. The market will start to recognize this value in advance with technical and commercial progress. Risks to this estimate: The defense business may not succeed and the industrial business may not grow.

Management: founders, family, long-tenured. nLIGHT was founded in 2000 and its three co-founders are still active in the business. CEO Scott Keeney was previously CEO of Aculight Corporation. Aculight was a laser defense company purchased by Lockheed a few years after Scott left. Mark DeVito is VP of Device Engineering, and Scott Karlsen is an optical engineer. Founder CEOs tend to think long-term, which matches John’s investment time horizon. We want nLIGHT’s management to make appropriate investments, like the defense business, that may not pay off for several years.

nLIGHT fits John’s criteria of a “hidden compounder”, as it is investing in manufacturing capacity and the defense business, and has the potential to be 5-10x its current size. The U.S. DoD has a pressing need for fiber laser defense systems to combat the asymmetric threat from low-cost drones. When fiber laser systems are ready, their adoption could be rapid.

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About the instructor:

John Barr manages the Needham Aggressive Growth Fund, NEAGX and co-manages the Needham Growth Fund, NEEGX. He has managed these funds since January 2010. John started on Wall Street in 1995 with Needham as a sell-side analyst following technical software companies, including electronic design automation (EDA) companies. John rejoined Needham in 2009 because of the culture, which lives and breathes growth companies and long-term investing.

From 2000-2002, John was a managing director and senior analyst at Robertson Stephens, following semiconductor technology companies. He was an Institutional Investor All-Star and was ranked by Reuters as leader of one of the top software teams. In 2002 John moved to the buy-side and joined Buckingham Capital Management where he served as a portfolio manager and analyst for their diversified industry long/short domestic equity hedge fund.

John’s first career was outside of Wall Street, where he spent 14 years in sales, marketing and management, primarily in the EDA industry. Working in these small companies makes him think like an owner and to look for that trait in his investments. John loves the challenge of identifying businesses with compounding characteristics and getting to know the companies over the course of years. From his industry experience, he looks to invest in companies that he would have liked to have been part of.