When most consumers think of the Internet of Things (IoT), a smart home speaker, a wearable device like a watch or earbuds, or some other type of equipment hooked up to a network may come to mind. But is that definition too narrow?

Small IoT chip designer Impinj (PI -4.92%) thinks so. To date, the radio frequency technology that the company helped pioneer has connected tens of billions of random items to the internet -- equipment in a company's possession, merchandise moving through supply chains, even pieces of clothing sitting in a store.

It's been a high-growth business since the Seattle-based company's initial public offering in 2016, but shares have recently taken a massive tumble, down 50% so far in 2023. What happened? And is it time to buy ahead of a potential recovery in the stock?

The chip downturn finally comes for Impinj

The secret to Impinj's success lies in the cheap and tiny radio frequency ID semiconductor chips it designs and sells. The company taps Taiwan Semiconductor Manufacturing to make these little chips, but they're far from the advanced silicon many associate with TSM. Impinj says its RAIN radio frequency identification (RFID) chips, which require no power, cost just pennies each. Tower Semiconductor manufactures the RFID reader chips for Impinj's scanners.

That cheapness is what gives a growing number of businesses the ability to add these small bits of silicon to virtually any items, embed them with information, then use RFID readers and scanners to keep tabs on the items. Besides offering the hardware needed to read the RFID tags, Impinj also offers software for companies to manage their IoT-powered operations -- although offering a more robust software ecosystem would be an improvement for Impinj's own business.

Use cases abound for this brand of IoT. One key area Impinj has been working on with customers is retail, where item tracking can help fight back against theft (or "shrinkage," as the retail industry calls it). Other promising areas have included supply chain management and inventory management.

But what of this sudden steep drop in share price? The semiconductor market has been in turmoil for the last year, due to an overhang in inventory left over from the boom in consumer electronics sales during the pandemic. Up until this point, Impinj was still selling lots of product, but now its customers (especially in retail) are also dealing with the same chip over-inventory problem.

Impinj management said it's going to report declining sales for at least the second half of 2023, and it's still too soon to say what 2024 will bring. For Q3 2023, Impinj expects revenue to decline as much as 25% from the quarter prior to a range of $63 million to $66 million.  

A best bet on IoT?

This near-term weakness could set up a buying opportunity, though. Impinj is expected to sell lots more RFID chips and scanners in the years to come, and it's working on new software (which theoretically should carry higher profit margins) to help customers manage their IoT-powered operations.

For the record, Wall Street analysts think Impinj revenue will grow at an average of over 20% annually for the foreseeable future. If that's true, the impending downturn will merely be a bump in the road.

That said, Impinj has business model issues to sort out. Selling these cheap RFID chips and readers and scanners doesn't carry much in the way of profit. Adding more software services to the mix will be key to this becoming a more robust and sustainable business. Up to this point, the company has only flirted with turning a corner on generally accepted accounting principles (GAAP) net income and free cash flow

PI Revenue (TTM) Chart

Data by YCharts.

It is also worth noting that Impinj had $109 million in cash and short-term investments at the end of June 2023, offset by debt of $281 million. It's not exactly a clean balance sheet, and it presents an additional risk for this small business.  

Given its lack of profitability, there's no good way to stick a meaningful value on Impinj right now. Shares do trade for 4.5 times trailing-12-month sales. If the company can grow as fast as it has been (20%-plus revenue growth), and start turning a profit with a more robust software portfolio, this could be a solid bet on a small-cap chip stock.  

I'm monitoring Impinj stock. Shares could continue to fall depending on how deep the downturn gets in the second half of 2023, so I'm not buying just yet. But if you expect a snapback in this IoT business, it could be worth a nibble in the coming months. Stay tuned.