After some shuffling of its business in the last couple of years, small IoT (Internet of Things) chip stock Semtech (SMTC 3.08%) has fully completed a boom-to-bust cycle. After nearly doubling in value from 2020 to late 2021, Semtech stock is now down more than 80% from those late 2021 all-time-highs and remains near multi-decade lows.
Management is predicting sales to remain relatively stable in the next quarter, but profit margins to dip further as global economic worry mounts. By some measures, though, Semtech stock could be a great long-term value. Is the stock worth investing in right now?
Growth is coming, but at what cost?
Semtech is a chip designer and components assembler for IoT systems, and also has some software that helps customers manage their networks of IoT devices. Currently, the company broadly organizes its business into three sections: Infrastructure (cloud data center, 5G and other wireless network equipment, broadband internet equipment), Industrial (sensors for manufacturing machinery, factory automation, automotive chips, video chips), and High-end Consumer (connectivity chips for PCs, smartphones, other consumer electronics).
On the surface, it seems like Semtech is bucking the current and mounting down-cycle for industrial and communications chips. In second-quarter fiscal 2024 (the three months ended in July 2023), Semtech reported revenue of $238 million, up from $209 million the year prior. And for the third quarter, management said revenue could be as high as $210 million, up from $178 million the year prior.
This growth isn't free, though. Indeed, it's coming at a high cost. Semtech acquired fellow IoT company Sierra Wireless at the start of 2023. Sierra Wireless' Q3 calendar year 2023 revenue (which corresponds to the Q3 fiscal year 2024 for Semtech) was $166 million. Add that to Semtech's $178 million in revenue in Q3 last year (for a total of $344 million), and suddenly that as-high-as-$210-million outlook doesn't look so hot.
As for the cost of acquiring Sierra Wireless, Semtech paid an enterprise value of $1.2 billion. It did "nearly double Semtech's revenue," but the rationale for the tie-up was rapid cost-cutting initiatives within 12 to 18 months, with that newly formed merger revenue as a base. With Semtech's chip and IoT markets suddenly in a downturn, cost-cutting can't happen soon enough. The company's profit margins have turned deeply negative, with free cash flow and GAAP net losses dialing in at negative $137 million and negative $440 million, respectively, over the last reported 12-month period.
Data by YCharts.
At the end of July, Semtech reported cash and short-term investments of $148 million, and total debt of $1.86 billion. In October, management noted it sold another $250 million of convertible debt to help fund operations. That's also not a great look in a higher interest rate environment, but unfortunately, it's what the business needs right now.
A high-risk, only potentially high-reward stock
Semtech's IoT chip business is exposed to some markets that should eventually recover, and that could overall be big growth opportunities in the decade ahead. Semtech could thus be a turnaround story at some point.
Understandably, the market has its doubts and has punished the stock, given its current money-losing business and high burden of debt. Shares currently trade for about 2.7 times enterprise value to trailing 12-month revenue, about half of how it was valued a few years ago.
If Semtech can stem its losses and hold out for a rebound in chip sales, perhaps there's massive upside from here. Some small-cap stock investors might be eyeing this too, and mulling an addition of Semtech to a diversified basket of small-caps with this as an underlying expectation. After all, with sales down so much in recent quarters since the Sierra Wireless merger, an eventual up cycle (which is already taking hold in some areas of the semiconductor industry, like in smartphone and PC sales) could be right around the corner. Perhaps Semtech could rocket higher once there's an indication the worst is in the rearview mirror.
However, this looks like a highly risky and only potentially high-reward investment at this juncture. For most investors, I believe this small chip stock should be observed from the sidelines for now, until there's a clearer signal that the company can survive and thrive over the long term.
