Smith Micro Software: The iPhone Alternative?

| About: Smith Micro (SMSI)

Whenever a giant, well-funded corporation jumps into a market dominated by a small company, executives at the smaller business always sing the same tune – something along the lines of: “We welcome the competition. It legitimizes our market.”

Unfortunately, the little guys are usually whistling past the graveyard – or on their way to it.

Smith Micro Software Inc. (NASDAQ:SMSI) would seem, at first glance, to be in exactly that position. The company’s big money-maker is software that sounds familiar to anyone who has ever heard of the iPod: its Music Essentials program allows people to download music from the Internet onto their PCs and then zip those tunes over to a handheld device for easy on-the-road listening. The big difference: the portable device is a cell phone, not an iPod.

Now Apple, Inc. (NASDAQ:AAPL) is turning up the volume. On June 29, it is planning to unveil its long-awaited iPhone, first announced back in January. It’s an impressive piece of engineering. The iPhone uses wi-fi to connect to the Internet, and includes a Web browser and Google Maps. iPhone can play video on a high-resolution screen, and can download music just like an iPod. These features, along with Apple’s famously elegant design prowess, make Smith Micro’s software look like last year’s technology – which it is. It was first introduced in January 2006.

But there are two problems with the iPhone. It comes with a hefty price of $500 to $600, and will be available only to people using AT&T Inc.’s (NYSE:T) cellular service.

That leaves space for Smith to grow. SMSI is “the only offer that counters AT&T and the iPhone,” says Amit Dayal, an analyst with Rodman & Renshaw. Last November, Verizon Communications Inc.'s Verizon Wireless (NYSE:VZ) became the first to release phones with Smith Micro’s music software. Since then, Music Essentials has become Smith Micro’s biggest product line. The company reported $17.7 million in revenues in the first quarter, up 79% from a year ago, with pro-forma net income up 114% to $6.2 million ($0.21 per share.) On a GAAP basis, earnings were $1.84 million, compared with $1.81 million a year ago. Sprint signed up for the service early this year (that service has not yet been started).

Smith Micro’s market cap is about $372 million. Its P/E hovers around 24. Because Smith Micro is the only significant player in music for cell phones, it’s hard to find a good company for comparison.

The company has had a long and winding road since its IPO in 1995. It was a pre-dot-com company, providing software for fax modems. The dot-com boom became a bust for Smith Micro as the internet rendered fax modems obsolete. The stock slid from around $20 in mid-1996 to under $1 by October 1999. But the company moved into new lines of software, such as software compression programs for the Internet, and it took off again, reaching $32 in March 2000. It has not seen that price since.

Smith Micro went down with the crash in mid-2000. It bottomed out in October 2002 at $0.17, and started another comeback by moving into communications software for the wireless industry. Since then, it has been largely a growth stock, albeit with a lot of volatility along the way, particularly in the last year, because of enthusiasm over its music software and concerns about the iPhone. Smith Micro is also working on software to add video to cell phones.

The stock hit a 52-week low of $9.01 in August 2006, and a high of $21.20 in April 2007. Then Jefferies & Co. dropped its recommendation from Buy to Hold, while Rodman & Renshaw downgraded it to Market Perform on May 3, largely on concerns over delays in implementing its software for Microsoft’s Vista operating system. Since then, the stock has dropped again to around $13.

But Rodman & Renshaw’s Dayal thinks that the concerns have now been factored into the price, and sees strong growth and a rising stock price for the second half of 2007 and all of 2008. Because of Apple’s offering, Dayal expects both cellular carriers to start a marketing blitz touting their own music features in the second half of this year. ThinkEquity Partners, which co-managed a secondary offering for Smith Micro in December, came out with a Buy recommendation on April 19, with a target price of $23, betting on a boost from Sprint later this year.

What’s an investor to think? This is likely to be a volatile stock at least until its second-quarter earnings are announced. The phones from Verizon and Sprint may end up being seen as the Poor Man’s iPhone. But for anyone willing to bet that the iPhone will make people lust for more cell phones with music, SMSI could be a hit. For now, it’s the only other tune playing.

SMSI 1-yr chart


Disclosure: none