Sierra Wireless (SWIR +0.00%) was a hot Internet of Things (IoT) play a few years ago, delivering impressive double-digit revenue growth and setting the stock market on fire thanks to its laser-like focus on a nascent but fast-growing market.
As a pure-play IoT company, Sierra looked all set to switch into a higher gear in 2017 as it struck partnerships with notable companies such as Volkswagen. The chipmaker turned in a mixed performance in 2018 before it lost its way last year -- reporting a double-digit revenue drop in 2019 as it tried to cut costs and transform the business model.
Sierra isn't in great shape this year either. Though shares of the IoT specialist shot up nearly 150% between April and August, thanks to a few positive developments, they have given up some of the gains over the past few weeks. Should investors treat this as an opportunity to buy more shares?
Image source: Getty Images.
Sierra Wireless seems to be pulling the right strings
Sierra Wireless has given investors a few reasons to cheer of late. The company sold its automotive embedded module business in July for $165 million. Sierra is looking to build up revenue from recurring sources such as services and software and get rid of the challenges it has been facing in the hardware business. The pivot to a recurring revenue model is expected to boost Sierra's margin profile.
The embedded broadband business (which the automotive business was a part of) is a low-margin business. The company generated $62 million in revenue from this segment last quarter and incurred nearly $47 million in cost of sales, which translates into a gross margin of just over 24%. For comparison, Sierra's IoT solutions business delivered $81.8 million in sales last quarter at a cost of $51.3 million -- a gross margin of 37.2%.
There is further scope for margin expansion, as Sierra's recurring revenue came in at $28.1 million in the second quarter, around 20% of the company's total revenue. Additionally, Sierra estimated that it would be able to reduce operating expenses by $20 million after the sale of its automotive business.
More importantly, Sierra can use the proceeds from the sale of the automotive business to bolster its position in other lucrative spaces such as IoT connectivity services, managed IoT solutions, and industrial edge-to-cloud connectivity.
Mordor Intelligence estimates that the IoT managed services space could clock an impressive compound annual growth rate (CAGR) of nearly 28% through 2025. The industrial IoT market could be another boost for Sierra, as it is estimated to clock a CAGR of 29.4% through 2025, according to Grand View Research, Inc.
Sierra has been targeting these markets with end-to-end solutions by integrating both hardware and software elements. This could be a better approach, compared to selling just hardware, which tends to get commoditized when lower-priced competitors enter the market. Instead, selling the required hardware and charging a recurring fee for the software services could be more fruitful, as it will allow the company to build a stickier customer base over time.
Should investors take the plunge?
Sierra Wireless is expected to go through a transition in the forthcoming quarters. Its top and bottom lines can be expected to move south, as the automotive embedded business had delivered $166 million in revenue last year, accounting for 23% of the total.
But at the same time, Sierra anticipates its recurring revenue to increase 26% this year, to $125 million. The transition to a higher-margin model should bode well for Sierra in the long run and help the company increase its earnings power. As such, investors looking to buy a pure-play IoT company should keep an eye on Sierra Wireless stock, as it trades at 22 times last year's earnings and looks capable of delivering more upside.
