My previous article on Sierra Wireless (NASDAQ:SWIR) concluded that this hot Internet of Things stock is not without its red flags. On a positive note, we have not found any glaring non-starters, and the company has relatively low margins for its industry, giving it the opportunity to improve profitability. In this installment, we now ask: What is the turnaround plan, and is there any substance behind it?
To figure that out, I first turned to the company's most recent annual report. In the CEO letter, Jason Cohenour starts by noting 2014 was "our first full year as an Internet of Things pure-play business." The strategy section of the report also opens by stating, "The IoT [Internet of Things] market is expected to grow significantly over the next decade," while the most recent investor presentation says that ABI Research expects the number of devices connected to the IoT to grow from 1.4 billion in 2012 to 12 billion in 2020, an annualized growth rate of 31%.
Turnaround plan: ride the Internet of Things
So in short, the core strategy behind the turnaround plan is to ride the emerging IoT wave. That reinforces our previously noted concern that Sierra Wireless sounds like what legendary investor Peter Lynch called a "whisper stock" -- long shots with a great story and lots of sizzle but no substance. He noted that they typically offer a very imaginative or complicated solution, but the story usually has an emotional appeal, and the company is usually unprofitable.
Perhaps most importantly, Lynch includes whisper stocks on his list of "stocks to avoid" -- so how real is this IoT opportunity?
Opportunity or hype?
When it comes to assessing the outlook for new technological trends, Gartner's annual Hype Cycle for Emerging Technologies can be invaluable. Its most recent update, in 2014, is shown in the following figure.
The Internet of Things tops the chart -- and that is not good. Gartner placed IoT at the point of a technology lifecycle that it refers to as the "Peak of Inflated Expectations." During this phase, "Early publicity produces a number of success stories -- often accompanied by scores of failures. Some companies take action; many do not." This phase is followed by the "Trough of Disillusionment," a period when "[i]nterest wanes as experiments and implementations fail to deliver. Producers of the technology shake out or fail. Investments continue only if the surviving providers improve their products to the satisfaction of early adopters."
As you can see, the IoT could signal both boom or bust for Sierra Wireless.
Mainstream adoption in Gartner's hype cycle starts only after an emerging technology passes through more phases including the "Slope of Enlightenment" and "Plateau of Productivity" -- the latter of which marks the end of the emerging technology lifecycle. That is when "[c]riteria for assessing provider viability are more clearly defined. The technology's broad market applicability and relevance are clearly paying off." In 2014, Gartner forecasted the IoT will reach that final phase in five to 10 years meaning its mainstream adoption would not begin until some time between 2019 and 2024.
Wall Street loves a story stock
Of course, a long wait and treacherous path before a hot, new trend goes mainstream has never stopped Wall Street from pushing a stock with a good story. To gauge hype for the IoT, we can turn to Google Trends, which shows the popularity of Google search topics over time. Beginning in 2013, IoT interest accelerated rapidly and continues to grow at a rapid pace, as shown by the blue line in the chart below
That upward trajectory is all Wall Street needs for a good story. But note that its search popularity has also waned recently. Though it is too soon to call, this could signal the IoT is approaching or entering the Trough of Disillusionment.
We have seen this before
For comparison purposes, the red line in the chart is for 3D printing, which was at the peak of the Gartner hype cycle in 2012. By last year, consumer 3D printing -- the subject of much of the buzz -- was on a downhill path heading toward the Trough of Disillusionment. That disillusionment has certainly set into stocks in the sector. 3D Systems Corp. (NYSE:DDD) is an industry leader that has heavily touted consumer 3D printing. As interest in this technology grew, so did the company's stock price and valuation. That hype has moderated, and the stock price and valuation multiples collapsed.
Like Sierra Wireless, 3D Systems intended to ride an emerging technology wave through both organic growth and acquisitions. But the company's organic revenue growth slowed from 29% in 2013 to 13% in 2014, its earnings per share deteriorated, and its operating cash flows did not reflect revenue growth.
3D Systems was not the only one to experience this weakness, as competitors like ExOne and Stratasys have seen similar underperformance with both companies trading down some 80% or more since the beginning of 2014. The moral of this story: Hitching a wagon to an emerging technology does not guarantee long-term profits and success.
The essence of the turnaround plan at Sierra Wireless is to ride the IoT wave. As promising as this technology seems, it could very well be suffering from inflated expectations. Furthermore, smaller players like Sierra Wireless are going to have a more difficult time weathering the rocky development cycle than larger competitors that are pouring billions of dollars into this technology.
In the end, this company looks like a risky "whisper stock." However, that does rule out this investment altogether. In my next article, I will determine whether specific opportunities at the company or a strong management team increase the likelihood that Sierra Wireless can be a long-term IoT success story.