Sierra Wireless (SWIR) is a pure play Internet of Things (IoT) specialist as it is in the business of making embedded modules and modems that are necessary to connect devices to the internet, which is what the IoT is all about. This is a great business to be in as sales of IoT chips are expected to increase at an annual rate of 15.1% over the next five years, hitting over $17 billion in revenue by 2023.
Sierra, however, has ended up being disappointing as its growth hasn't been as aggressive as the IoT market in general, though investors' patience could pay off thanks to a set of strong catalysts.
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Sierra hits a wall
Sierra has recorded irregular top-line growth over the past few years, notching an 11% year-over-year bump in 2015, followed by a jump of just 1% in 2016 and then a 12% increase in 2017 as Sierra acquired three companies to bolster its hold over embedded machine-to-machine connectivity modules, where it holds an impressive market share of 33%.
And investors have sent the stock down more than 50% over the past three years.
Waiting for catalysts to kick in
Sierra's top-line growth hit a respectable level last year, but a closer look indicates that all isn't well with the chipmaker. The company got 80% of its revenue from the OEM Solutions business last year by supplying embedded modules and application software to its OEM (original equipment manufacturer) customers that are spread across several verticals such as automotive, energy, and networking.
But demand from these customers has remained weak over the past couple of years. For instance, the OEM business grew just 7% in 2017 following a decline in 2016. What's more, Sierra's OEM revenue growth faded after an upswing in the second quarter of the year.
Data Source: Sierra Wireless. Chart by the author.
The health of the OEM Solutions business is critical to Sierra's long-term growth as it does most of the heavy lifting when it comes to the company's revenue, making up 80% of revenue in 2017. CEO Jason Cohenour is optimistic that this segment will gain momentum as the year progresses thanks to the ramp-up of new customer programs and recent design wins.
Cohenour said during the February conference call with analysts that Sierra has "secured a growing number of new programs across a range of segments, including automotive, networking, transportation, energy and mobile computing," and scored its second-largest design win in the automotive space. This new automotive program is expected to go online in late 2019, but before that, Sierra should start enjoying the benefits of its earlier contract win at Volkswagen.
Sierra scored a design win to supply its connectivity modules to the German auto giant more than a year ago. Volkswagen is expected start shipping its new models this year with Sierra's embedded modules, but the benefit for Sierra Wireless won't be immediate. "... 2019's a pretty big ramp year on Volkswagen and other programs. And '20 is when we really expect to see a very large contribution from these large automotive programs that we won," Cohenour said during the February conference call.
Meanwhile, Sierra's foray into low-power wide-area (LPWA) devices should start bearing fruit soon, as these devices will play a critical role in enabling communication between IoT devices. The chipmaker has been busy shipping samples of its AirPrime LPWA modules to carrier partners in North America during the test phase, and it claims to have scored some initial design wins, including a Japanese customer that's expected to start deployments later in 2018.
Sierra, however, has clarified that the LPWA business will start gaining critical mass from 2019. But investors' patience could be rewarded in the long run as LPWA connections are expected to increase from just 59 million in 2016 to 3 billion in 2025, according to Machina Research.
Sierra is diversifying
So, Sierra's OEM business might not make a big comeback this year, but the solid catalysts clearly indicate that it could pull the company out of mediocrity in the long run. In the meantime, the rapid growth of its other two businesses should give Sierra's top line a much-needed boost.
Sierra gets close to 15% of its business from the enterprise segment, while the IoT services business accounts for just 5% of the total top line. The good part is that these businesses have gained terrific traction in recent quarters. For instance, the enterprise business grew a whopping 52% year over year during the fourth quarter as demand for Sierra's telematics products that are used in truck fleets increased.
Sierra expects the terrific growth of this segment to continue this year as more of its transportation customers add telematics devices to their fleets. More importantly, the fleet management market is expected to record annual growth of 16% through 2022.
Meanwhile, the IoT services business has been boosted by the Numerex acquisition as revenue increased 73% year over year, while organic growth stood at almost 28%. The IoT services business might be just a small part of Sierra's overall business, but the good part is that over 90% of the revenue is recurring in nature.
Not surprisingly, this business enjoys an extremely strong gross margin of 44.5%, which is well above Sierra's 2017 gross margin percentage of 34%, so it should eventually contribute toward a stronger bottom line.
What should investors do?
Sierra's biggest business is yet to take off as expected. The good part, however, is that OEM Solutions could start reporting strong growth sooner rather than later as Sierra's design wins turn into revenue on the back of new product ramps. This is probably why analysts expect the company's earnings to grow at almost 18% a year for the next five years.
This potential growth makes the stock a good buy as it trades at just 17.4 times the forward earnings estimate, which is fairly cheap considering it has a very expensive five-year average price-to-earnings ratio of 119.
The bears might argue that Sierra has a very patchy track record of growth, but its relatively cheap valuation, the IoT opportunity, and the fact that it trades close to its 52-week low make it a good bet for investors looking to get in on the IoT revolution.
