I recently pointed out that Sierra Wireless (SWIR), the world's leading manufacturer of 2G, 3G, and 4G embedded modules and gateways, was a great "pure play" on the Internet of Things (IoT) market. That market, which includes billions of devices connected to each other and the cloud, could grow from $171 billion this year to $561 billion by 2022, according to research firm Markets and Markets.
I previously noted that Sierra's market-leading position, inorganic growth strategy, and the expansion of its software ecosystem made it a good long-term investment. But today, I'll analyze the risks facing Sierra Wireless -- and see if they could sink the stock.
Source: Getty.
Sluggish OEM sales in 2016
Throughout most of 2016, Sierra posted revenue declines at its core OEM Solutions business. Sierra attributed that slowdown to "softer demand with certain established OEM customers".
|
Q1 2016 |
Q2 2016 |
Q3 2016 |
Q4 2016 |
Q1 2017 |
|
|
YOY growth |
(9.1%) |
(4%) |
(2%) |
11.2% |
10% |
|
% of Sierra's revenue |
85% |
85% |
83% |
83% |
82% |
Source: Sierra Wireless quarterly reports.
But over the past two quarters, OEM orders rebounded on rosier demand across the automotive, energy, networking, payment, and mobile computing markets. Sierra's acquisition of the assets of GlobalTop Technology's GNSS (global navigation satellite system) business strengthened the business further.
More importantly, the overall weight of the OEM business has gradually declined, thanks to the growth of its smaller Enterprise and Cloud & Connectivity businesses. The Enterprise business, which posted 45% sales growth last quarter, was strengthened by Sierra's acquisition of GenX Mobile last year. The Cloud business, which processes data from its gateways and modules, reported 2% sales growth.
With Sierra firing on all cylinders, analysts expect its revenue and earnings to respectively rise 10% and 53% this year -- so soft OEM sales should be less of a concern going forward.
What about the competition?
Sierra Wireless controls 33% of the M2M (machine-to-machine) embedded module market. Its closest rivals are Italian wireless equipment vendor Telit Communications and Dutch digital security firm Gemalto -- neither of which is publicly traded on U.S. exchanges.
Several years ago, analysts feared that lower-margin Chinese rivals could challenge Sierra's dominance of the market. But Sierra aggressively scaled up by gobbling up a long list of businesses -- including Qualcomm's (QCOM -1.53%) CDMA module business, wireless connectivity players AnyData, Maingate, Mobiquithings, GenX Mobile, and GlobalTop's GNSS assets. Those purchases widened Sierra's moat against its potential rivals, and enabled it to expand its gross margin over the past decade.
Source: YCharts
Cash flow and debt levels
Expanding with acquisitions is a costly strategy, and Sierra's cash position fluctuates wildly. It finished the first quarter with $92.5 million in cash and equivalents, which represented a 10% sequential decline from $102.7 million at the end of fiscal 2016.
But if we look back further and compare Sierra's cash position to its free cash flow over the past decade, we'll see that the company usually keeps its cash flows in positive territory:
Source: YCharts
As a result, Sierra Wireless currently has no debt. That clean balance sheet, along with its fairly low market cap of about $900 million, seems to make Sierra a lucrative buyout target for any chipmaker that wants to dominate the M2M modules market. The company would be a natural fit for Qualcomm, which has been expanding into adjacent markets and already holds extensive supply and licensing agreements with Sierra.
But mind the valuations...
Unfortunately, Sierra's Achilles' heel is its valuation. After rallying more than 60% over the past 12 months, its trailing P/E of 64 is much higher than the industry average of 31 for communications equipment makers.
Its forward P/E of 27 looks more reasonable, but it still doesn't seem terribly cheap. That's probably why there hasn't been much buzz about Sierra being acquired. Therefore, investors who don't own Sierra should probably wait for a pullback before starting a new position.
... and take the IoT hype with a grain of salt
Much of the market enthusiasm for Sierra stems from bullish forecasts for the IoT market. However, investors should take those forecasts with a grain of salt.
Initial demand for IoT products could be throttled if next-gen products like wearables, connected cars, and smart home appliances aren't embraced by mainstream consumers. Vicious cyber attacks and data breaches could also convince companies and consumers to stick with "dumber" non-connected devices. Therefore, Sierra remains the best "pure play" on the IoT market -- but investors should have realistic expectations for the stock.
