Sierra Wireless (TSX: SW) Beat Down Sets Up an Attractive Entry Point

Alex Cutulenco Alex Cutulenco | Ubika Research Analyst | February 23, 2016: Sierra Wireless (NASDAQ: SWIR) (TSX: SW) shares have underperformed the S&P 500 by 60% over the last 52 weeks, which makes us wonder if the selloff is warranted, and if this has created an investment opportunity for those looking to get into the IoT sector.

Summary:

• Company released weak FY/2016 guidance, after missing management estimates over the last two quarters
• Share price has underperformed the S&P 500 by 60%, giving rise to a potential value-play entry point
• With management’s guidance of $1 billion revenues by 2018 and 10%+ in operating profit margins, PT should be close to US$23

Figure 1: Sierra Wireless vs. S&P 500
 Source: Thomson Reuters (02/22/2016)

The Company released its FY/2015 results on Feb. 4th, reporting a surprising operating loss after five consecutive quarters of operating profits, while also reporting a 2.8% decrease in Q4/2015 revenues (as compared to Q4/2014).

Figure 2: Company operational performance for FY/2015
 Source: SEDAR filings

The Company also provided a dismal 2016 outlook, expecting to see soft revenue growth of ~7%, with a marginal rise in operating profitability. This outlook is fueled by management’s expectation of a:

o Demand turnaround from its OEM revenue segment (with particularly meaningful contribution from the auto, PC, and energy market customers);
o Revenue growth in Enterprise Solutions and Cloud & Connectivity Services to outpace growth in OEM segment
o Profit margins will increase as AirVantage Cloud solutions start to scale (division currently broke even, and is one of the higher profitability businesses in Sierra’s arsenal)

Lastly, the Company also projects to achieve $1 billion in revenue by 2018, targeting gross margins of 35%+ and operating margins at 10%+. Given these management’s projections, and applying certain valuation assumptions, we developed several valuation models for Sierra.

Case 1 – Management’s Projections: Target Price of $23.00 with an upside of 95%

• Revenue growth from $608mm in 2015 to $1 billion in 2018
• Operating margins from 1.7% in 2015 to ~10% in 2018
• WACC of 16% (based 2-year weekly beta of 2.6, MRP of 5.5%, and Rf of 1.77%)
• Capital expenditure projected at ~2.5% of revenues, with levels in depreciation and WC similar to those faced in previous three years

Case 2 – Our much more conservative estimates: Target Price of $15.50 with an upside of 30%

• We forecast prolonged softness in OEM sales as the macroeconomic outlook weighs in on sales throughout 2016; Sales reach $1 billion at the end of 2020
• As Enterprise and Cloud & Connectivity divisions represent a relatively small portion of revenues, therefore we are forecasting a marginal impact on profitability in the short-medium term

Additionally, on a LTM basis, Sierra Wireless is trading at a steep discount to industry peers on an EV/Revenue and EV/EBITDA basis.

Conclusion:

Although management had a string of two consecutive misses already, we believe that they have chosen to go with conservative estimates for 2016 in order to suit the market. Additionally, the shares have been punished to a point where a technology company now trades at below 0.5x 2016E Revenue. We believe that the combination of: (i) market softness within the OEM division, as well as (ii) increased competition within the Device-to-Cloud Solutions in the IoT sector are both worrisome factors. The Company’s strong leadership team and experience, though, give us comfort in judging its business as robust.

At this moment, we believe investors should wait and see what the next quarter of earnings delivers, and if the Company picks up steam in its three operating businesses.

Questions or comments? Alex can be reach at: alex@gravitasfinancial.com

Read more Analyst Insights from Alex Cutulenco ⇒

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