Novatel, Sierra Wireless: Game Over

Novatel (NVTL) and Sierra Wireless (SWIR) produce wireless datacards, usb modems, and embedded wireless modules in PCs to connect to carrier networks. They have enjoyed favorable pricing and strong margins as their stocks have run up over the last year. The bear case had always been that larger competitors would enter the market and price them out.

Well, it seems that the bear case is playing out now as Qualcomm (QCOM) has introduced their Gobi wireless solution and sources indicate that FoxConn will be producing an embedded module which should help to crush Novatel and Sierra Wireless' margins. The price point is rumored to be around $80 compared to the current $120 - $150 that NVTL/SWIR charge. Simple math tells you that two things will happen: 1) these two will face severe pricing pressure and, 2) they will lose business to the larger competitors (Huawei, etc). Compound this further with the fact that these companies are one trick ponies for the most part and you could find them trading in the single digits very soon.

UPDATE: Deutsche Bank recently published a report stating that Ericcson (ERIC) Mobile Platforms is offering an embedded module in the $40 range for 2008. This is a significantly worse (better) pricing situation for NVTL and SWIR. Consider this - currently, their bill of materials is around $80-100 to produce these modules.

I continue to be short these names.

Disclosure: Author has a short position in SWIR and NVTL

Comments

[SWIR_NVTL_LONG]

Mr Griffin, You seem to out of touch with reality. What was an issue 6 months ago, you are playing the same tune over and over again. SWIR and NVTL addressed these issues any number of times.

1. Both the companies have locked in their Embedded business till YOY 2006 if not some into 2009 and beyond.

2. This is a very low margin business for them and will quit it at the first available chance should their margins near break even point. Remember, GOBI or Not, still the OEM's with their partners have to go thru the intense Certification process. This is where NVTL and SWIR excel at.

3. SWIR and NVTL are the best of breeds. Period. Consumers aren't going for GOBI until it's established. Not me.

3. SWIR has a dversification going on the M2M business unit (Read Airlink communications) which has a 53% margin rate at it's latest Q and increasing over 100% from Q/Q.

4. Have YOU heard their Conference calls at all or just bent on SHORT TRADE?

[BrianGriffin]

A company will never signal its own demise. I am led to believe that either they do not know that they are going to be priced out of the market or that they think they can compete at much lower price points.

I do agree that this may take some time to play out fully but the market tends to discount information 6-9 months in advance. Consumers will go for what works at a lower price any day. The lack of other best of breed competitors has been a function of the fact that this has been a very small market until now.

For an example of another best of breed company that was ruined when competitors entered their markets look no further than CSR LN and their bluetooth business. As soon as a market grows to a size where a BRCM or a QCOM feels that it is worth competing in, they will join in and compete on price.

SWIR and NVTL MUST diversify if they are to remain in business. They have purchased new businesses in the past and pursued new lines of revenue. These transactions are rarely reasons for stock prices to go up because a premium is usually paid and the uncertainties are many.

As for, SWIR's M2M business is close to 10% of their sales. This is hardly enough to help the company in the near term. Remember, if they quit this "low margin business" that means they are quitting on approx 25% of their revenues. That's a large hole to fill.

I have heard their conference calls and I am simply short because I believe that they represent overvalued companies with a catalyst on the horizon. I am far from infallible and if your research has led you to conclude that these stocks are good values then by all means purchase them. That is why the disclaimer appears on the site to do your own research.

Thanks for your comments and helping me to think about my positions differently.

[BrandonBarker]

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[BrandonBarker]

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[BrandonBarker]

Brian, I appreciate you taking a position and defending your position; however, I think your premise regarding Sierra Wireless is incorrect. Let's address this supposed new competition that you speak about. First off management has readily acknowledged that Gobi can result in new competitors in this PC OEM embedded space. What many short sellers fail to realize, however, is that while PC OEM embedded modules are of value, that value as of now is extremely limited. Why? Well for the 9 months ending September 30th, 2007, PC OEM embedded modules only accounted for 12% of the overall revenue or roughly $36.5 million dollars. What's more important is that these products have a low gross margin (low 20 percent according to management). Non-PC OEM modules accounted for 9% of revenue during this same time, and they have higher gross margins. These non-PC OEM modules are not being threatened by the new Gobi solution because this is a very fragmented market with low volume customers (see listing below). Management believes that there are several opportunities to grow within this area; therefore, I feel that too much emphasis is being placed on PC OEMs and Gobi. Management is confident that their overall OEM business will experience growth in 2008.

In addition, many short sellers fail to realize the value of the mobile/M2M space. During Q3 these products accounted for 10 million in revenue at a gross margin of 53%. This simply means that for every dollar made in the mobile/M2M space, PC OEM modules have to make roughly 2.4 dollars to equal the underlying value in mobile/M2M. This is huge because SWIR expects tremendous growth in this area. These products have primarily been sold in North America. However, in 2008 they are spreading this portion of their business to Europe and expanding in Latin America. This is a very fragmented industry with no one dominate player; therefore, the prospects of growth here are outstanding. In addition they have M&A plans for this area which should further growth. SWIR has 184.5 million dollars in cash and equivalents with no debt. They are comfortable with 60-70 million to run the business. Therefore, the rest can conceivably be used for M&A activity in this space, and they have voiced their intentions to acquire companies in this space. They were able to purchase Airlink for $31 million in Q2, and it was accretive to earnings in Q2 and in Q3. In fact it accounted for 9.5 million of the mobile/M2M business at that 53% gross margin. If you extrapolate that out, you've got about a yearly $20 million dollar gross profit from a $31 million acquisition. That's quite some acquisition, and I look forward to more acquisitions and future growth.

Finally we have to review the PC card/USB modem space. Competition in this space is nothing new. Huawei, Pantech, ZTE, Novatel Wireless, Option, etc. are not newcomers to this space. They have been around as long as SWIR has, but SWIR has managed very well. Over the past year, while faced with this competition, ASPs have remained flat. Acceptance is so great that SWIR's component suppliers can't keep up with demand. SWIR earnings estimates are limited in Q4 (to $0.35) due to a lack of component suppliers being able to keep up with demand.

I don't hold the same overall views for Novatel due to their lack of exposure in the mobile/M2M sector as well as their lack of non-PC OEM customers. However, they maintain that $500 million revenue in 2008 is easily surpassable.

In summary I find it hard to believe that anyone can justify a drop in SWIR from $28 to single digits based upon the belief that competition in the PC OEM sector will be the downfall of SWIR. This is such a minor portion of their business that it shouldn't make a heck of a lot of news, and dont think that they will go down without a fight. SWIR will likely hit an EPS of $1.15+ this year and $1.50+ in 2008. This for a company with no debt and currently $184.5 million or $5.86 in cash. Hardly a stock that I would short at $15. However, I am not short SWIR, you are. You may end up SOL (short out of luck) if you're not careful. I wish you well , but you may need to come over to the long side :)

SWIR Non-PC OEMS
-Cisco
-Digi
-Symbol
-Ericsson
-@Road
-Intermec
-Verifone
-DriveCam
-etc......


Take care,

Brandon

[yankeestation]

Hello: Am puzzled by what Mr. Griffin had to say about SWIR. Am tracking analyst estimates from a number of well established sites and they are consistantly rating SWIR positively, except for one or two of them. But there are more than 15 of them. My question to Mr. Griffin --if he is kind enough to answer-- is this: Why would these professional analysts continue to expect top results from SWIR in spite of everything you have said about what the future looks like for this Co.?
Many thanks for answering my question. bob schoos

[BrandonBarker]

As you all likely know, SWIR is on the prowl for acquisition opportunities. They currently have $184.5 million in cash of which only $60-70 million is needed to run the business. Therefore, we can potentially see $124 million being used for acquisition purposes. We can see even more if they decide to issue stock in conjunction with the cash offering as we saw with the Airlink deal. So what can we expect?

In Dave McLennan's (CFO) presentation at the Lehman conference on Dec. 4th, he mentioned that they are looking at the M2M sector for acquisitions. He said that they have several targets in the pipeline; however, for competitive purposes he was very general in his discussion. He did, however, mention that the acquisition could be game-changing or it could be something on the level of the Airlink acquisition which only cost about $31 million.

CIBC in a Q3 report discussed the possibility of an acquisition of a company such as Wavecom, a heavy player in the M2M business. This I would categorize as the game-changing type. They also briefly discussed a potential SWIR/Option merger. This on the basis that SWIR has a huge North American presence, while Option has a huge European presence. This too would be a game changer. Whether we give these possibilities credence or not, let's remember that CIBC did purchase 1,900,000 shares of SWIR at $22.40/shr. They did not do so blindingly. I imagine that they have more insight than I do, and I hope they're right. Also SWIR's management seems to have their act together when it comes to making acquisitions. Airlink only cost $31 million; however, it currently produces over $20 million in gross profit. One hell of an acquisition if you ask me.

I have no idea what their M&A plans are, but I think that we will go up tremendously based upon the existing business. If we add an accretive acquisiton such as discussed, we will all quickly forget about these dire days. Again, I'm not sure why anyone would risk shorting this powder keg, but their short squeeze will make me much more financially stable. I guess we shall soon see who's right!!!

Take care,

Brandon

[BrandonBarker]

Sierra Wireless Raised To Top Pick From Buy By Salman >SWIR

Last update: 1/3/2008 7:23:19 AM(MORE TO FOLLOW) Dow Jones Newswires January 03, 2008 07:23 ET (12:23 GMT)

[BrianGriffin]

@yankeestation: there is no shortage of examples where analysts are wrong on the prospects for a company -- take a look at most financial stocks in 2007 - in the end, they have no more information than you and I.
Further, analysts and human nature are eternally optimistic. Only a few weeks ago, everyone believed that we would avoid a recession and now economists are debating how bad it will be.