Lagging Hardware Weighs On Transitioning Sierra Wireless – Sierra Wireless, Inc. (NASDAQ:SWIR) No ratings yet.

Sierra Wireless (SWIR) prepares to deliver its 2019 Q4 earnings report on February 13, 2020, after a disappointing 2019 Q3 report sent its stock to the lowest point since 2016. From a peak of about $11.50, shares traded as low as $7.72 at the beginning of November after a bad earnings miss and a downgrade from Raymond James. Since then, investors have restored over half of the losses from that bearish period to a price of $9.59, just above the 20-day and 50-day moving averages. SWIR’s stock performance will, ultimately, be decided by the results of its transformation from a hardware-focused company to a software-focused one. Even though short-term fundamentals may cloud the success, it is likely that the IoT company has chosen the right markets to grow into in the long term.

Source: Finviz

Turbulence in Hardware

Earnings over the past year have been tough on SWIR as the company broke its streak of EPS and revenue beats to see both those numbers come in below Wall Street estimates in 2018 Q4. Earnings would take a heavy hit declining from $0.25 to $0.03 in 2019 Q3, a time of the year that usually produces one of the firm’s strongest earnings. This was likely precipitated by three straight quarters of year-over-year revenue declines averaging 8.88 percent. The 2019 Q3 miss was the largest as sales fell short of Wall Street estimates by 9.0 percent. After that earnings release, management announced new full-year revenue guidance at $708-712 million falling well short of a consensus estimate of $753.6 million. Shares dropped 13.5 percent in after-hours.

In an IoT market that continues to see growth, SWIR’s most recent 2019 Q3 results are disappointing. Revenue fell 14.5 percent from the year before due to “lower demand from certain hardware products.” Out of the two segments that SWIR reports, the Embedded Broadband segment reported the worst, down 25 percent YoY, going from the leading segment to the lagging segment. IoT Solutions’ performance was better with subscription services up 5 percent and enterprise gateway revenues up 14 percent (both software sub-segments). However, the larger segment was still down 2 percent because of softness in IoT Solutions hardware.

Investing in the Right Markets

The robust drop in Embedded Broadband is less scary when CEO Kent Thexton points out that management plans on “transforming to an IoT Solutions company with recurring revenue driven from IoT connectivity software and managed service offerings from a mostly hardware-only company.” In fact, a July 2019 report on the IoT market by McKinsey suggests that there will be more opportunities in IoT software applications than the more mature IoT device/hardware market segment.

Source: McKinsey

With 25 percent of businesses using IoT technologies (up from 14 percent in 2014), the continually maturing device/hardware market is setting the stage for innovation in software to enhance the application of the 43 billion connected devices that are expected to be online by 2023. McKinsey suggests that growth in short-range and wide-area networking technologies will see robust annual growth at 20 percent and 30 percent respectively through 2022, segments consistent with SWIR’s enterprise gateway offerings and its development of LPWA and 4G solutions. Meanwhile, the “mature” device markets, smartphones, personal computers, and tablets, will see 0-3 percent growth annually in the same time period. Embedded Solutions relies on developments there.

Source: Bain & Company

Another report from Bain & Company in August 2018 pegged software and networking as the markets with the most potential over hardware. In particular, systems integration and data center/analytics products will see the most growth between 2017 and 2021 with estimated CAGRs of 40 percent and 50 percent. Interestingly enough, Bain also directs that “industry customization and intelligent packaging are emerging as keys for success” finding that 80 percent of IoT vendors target 4 to 6 industries, a number the consulting firm thinks is too broad. SWIR’s transition to minimize its Broadband Embedded segment might receive a nod of approval from this report.

Even if an investor looks at the McKinsey and Bain reports as a bullish signal for SWIR, the company is still far out from successfully transitioning to being software and network-oriented. Taking a small step towards its goal, SWIR purchased an IoT solutions business in the Asia Pacific region which should add $9.2 million to recurring revenues. While that effect should be immediate, management points out that organic “service wins often take about 18 to 24 months to start contributing to our P&L.” At the same time, they’ve set a goal to achieve $200 million in recurring services revenue in three years which equates to more than doubling a segment that was up just 7 percent YoY this past quarter.

What to Expect

Based on guidance, SWIR doesn’t see Embedded Broadband improving. Based on a combination of lower demand and restructuring, the segment is forecasted to be down 22 to 23 percent for the entire 2019 year, and it’s likely there will be a similarly dim projection for 2020. This seems to be capturing the headlines at the moment and keeping a bearish tone around the stock for the time being. Of course, with short-term forces like the coronavirus and trade complications at play, hardware demand could be lower than expected in the first two quarters.

Investors should not be caught up in a segment that is being phased out and, instead, should focus on subscription revenues in the Q4 report. SWIR management appears to have indicated that it will be the metric it uses to track the success of the company’s transformation. Q4 earnings will also continue to be focused on how subscription revenues margins compare favorably to hardware margins. In that case, investors should look to see improvement there as SWIR focuses on new economies of scale in the software segment. Both of these metrics are indicators of the future that will, ultimately, drive the long-term share price. Of course, if Q4 already shows some stalling in these metrics, it’s likely there’s a fundamental problem with the company that is might keep it from succeeding in successful markets.

Since the weakness in hardware seems to be clouding the long-term view of SWIR, there’s likely to be a bit more turbulence in its trading in the short term. At the current price, it seems safe to hold the stock through volatility, but there might be a buying opportunity if the stock drops below $9 into the $7.50-8.50 range. The 2019 Q4 earnings report might be the event that brings SWIR back down to that range.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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