Numerex: Exceptional Growth in the Emerging Machine-to-Machine Sector

Oct.31.10 | About: Numerex Corp. (NMRX)

Machine-to-machine (M2M) communications, also referred to as "the internet of things," has the potential to dramatically transform the way business is conducted in diverse and broad segments of the economy in coming years.

As defined by Numerex:

M2M communications consists of using a device (e.g., sensor, meter, etc.) to capture an "event" (e.g., temperature, inventory level, location, environment status, etc.), relayed through a network (e.g., wireless, wired or hybrid) to an application (software program), translating the captured event into meaningful information (e.g., there is a breach, corrosion requires attention, items need to be restocked, an accident has occurred, etc.)

Almost all inhabited parts of the world are now covered by cellular communications networks providing a medium by which sensors on machines can transmit information to be processed by software applications to provide valuable, real time actionable information to businesses, allowing them to achieve greater efficiencies in their processes to deliver goods and services to their customers. A classic example is a vending machine that utilizes M2M technology to diagnose its own operational status, automatically transmitting information such as inventory levels or required maintenance to a central location. A software application can process information received from hundreds or thousands of vending machines to generate a daily plan to efficiently dispatch exactly the right resources to each machine and optimally schedule the next visit by a maintenance person. As the number of sensors increases, and communications standards are established across not only companies but entire industries, it is possible to envision M2M applications which will vertically link entire supply chains from basic inputs and inventory control of components to manufacture, sale, delivery of a product or service including post sale monitoring and maintenance.

A fundamental advantage common to all M2M applications is that they serve to reduce what is typically the most expensive input: human intervention. A very common application of M2M today, for example, is utility meter reading. Rather than sending an employee to look at the number on the side of the meter, it is much less expensive to have the meter transmit usage levels over the cellular network to the computers of the billing department. Similarly, there are countless applications in health care, where M2M technology can automate data collection of patients’ vital signs, a task now carried out by highly trained (and expensive) health care professionals.

Logically, many companies are entering the exciting new growth industry of M2M communications, including many huge telecom players. However, I believe that the most compelling case for investing in the internet of things is offered by Numerex (NASDAQ:NMRX), an Atlanta based company which is achieving increasing success in establishing itself as a key player in this emerging sector. Numerex is increasingly recognized as the leading single source provider for companies seeking to implement M2M solutions. Numerex uses a high margin, subscription based, recurrent revenue business model that is just now achieving critical mass of over one million subscribers to achieve sustained profitability in the future.

For an excellent recent article on Numerex, I highly recommend Numerex's Ideal Business Model, published by Don McKiernan on Seeking Alpha on August 11.

Founded in 1988, Numerex is a microcap opportunity, but it is certainly not a start up. It is led by industry veterans, and is playing an increasingly central role in the establishment of crucial industry standards to permit expansion of M2M communications between diverse companies and industries. On October 28, Numerex released third-quarter results, which were highly positive and provide further proof of the thesis in the Don McKiernan´s article referenced above. Numerex earned five cents per share in the quarter, as compared to a loss of 15 cents per share in the same quarter one year ago. From the earnings press release:

GAAP earnings from operations were $751,000 compared to a GAAP loss from operations of $367,000 in the third quarter of 2009. The Company improved its sequential performance by 94% from the second quarter of this year.

Non-GAAP net earnings before non-cash charges and certain litigation related legal fees was $1.8 million during the third quarter of 2010 compared to a loss of $1.0 million for the same period last year. A reconciliation of this measure to GAAP results has been provided in the financial tables included in this press release.

Digital subscriptions increased to 1,102,000 at the end of the third quarter of 2010. This compares with 843,000 recorded at the end of the third quarter of 2009, reflecting a 31% growth rate.

A year-over-year growth rate of 18% in recurring M2M service revenues. During the third quarter of 2010, M2M service revenues as a percent of total service revenues were 97%, as compared to the same percentage in the third quarter of 2009.

For the quarter ended September 30, 2010, the Company reported consolidated revenue of $15.4 million compared to $11.6 million in the third quarter of 2009, an increase of 32%. During this quarter, the Company reported service revenues of $8.9 million and hardware revenues of $6.5 million compared to $7.6 million in service revenues and $4.0 million in hardware revenues, respectively, during the same period last year.

Consolidated gross margin for the three months ended September 30, 2010 was 44.6% compared to 44.2% during the same period last year.

I believe that Numerex is just now at the inflection point where they will enter many years of sustained, rapid growth in revenues and profits. The company remains 'under the radar' of almost all investors, as its microcap valuation makes it ineligible for purchase by almost all institutional investors. Currently selling at nearly 20x 2011 earnings of $0.41 per share, this is not a value play, but is it most certainly a very interesting microcap growth story. Fully 42% of the company’s shares are held by insiders, ensuring strong alignment of interests on the part of investors and management. At the same time, a disadvantage of the high insider ownership is that the stock has a limited float, with an average of only 16,000 shares trading per day. Numerex is by no means a trading opportunity, and I would not recommend investment in this share for short-term investors.

But for investors who like myself approach selected microcap shares as venture capital opportunities, seeking to multiply their initial investment over a maturation period of two to three years, I believe that Numerex provides an excellent investment. The 'internet of things' will no doubt transform our world in the coming years as companies seek to benefit from the efficiencies that M2M communications can provide in their constant struggle to cut costs and improve productivity. In my opinion, Numerex will play a central role in this new industry, and will see its market capitalization multiplied many times in this scenario. I highly recommend purchase of these shares for suitable investors at the current price.

Disclosure: long NMRX common shares