NOVATEL WIRELESS INC NVTL
July 02, 2013 - 6:03pm EST by
styx1003
2013 2014
Price: 4.06 EPS -$0.59 $0.32
Shares Out. (in M): 34 P/E N/A 12.7x
Market Cap (in $M): 137 P/FCF N/A 13.5x
Net Debt (in $M): -53 EBIT -6 16
TEV ($): 84 TEV/EBIT N/A 5.1x

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  • Telecommunications
  • Broadband
  • NOLs
  • Litigation

Description

At $4.06, NVTL provides a compelling risk/reward situation with limited downside ($3.50) and multiple catalysts over the next 6-18 months to realize our $7.50 price target. Beginning in Jan 2011 with ZTE Corp’s (ZTE) Mobile Hotspot product introductions at the Consumer Electronics Show, NVTL has faced a number of competitive, strategic, and operational issues that negatively affected fundamentals and investor perceptions. 2012 was a transitional year for management and NVTL is now well-positioned to realize increasing free cash flows and sustained profitability on 4G LTE roll-out and Machine-to-Machine (M2M) 15-20% industry growth rates. There could be further upside through additional market share gains in Mobile Hotspots, leverage to the M2M secular growth story, cost initiatives, and a positive ruling on a patent infringement lawsuit against ZTE.       

  • Mobile Hotspot Turnaround and Market Share Gains… Exit of Primary Competitor ZTE: the NVTL investment thesis is a familiar story across the telecom equipment space with company fundamentals (and stock valuation) driven by product cycles and design wins. Our $7.50 price target is based on reasonable revenue assumptions for Mobile Hotspots with multiple tailwinds. Most importantly, ZTE, which provided the $20 lower-cost alternative to NVTL’s premium-priced $50 MiFi and accounted for 2H2012 market share losses, is no longer available at Verizon Wireless (VZ). NVTL currently sells both value and premium Mobile Hotspots at VZ, launched with AT&T in late 2012, Bell Canada in 1Q2013, and will re-launch with Sprint in 2H2013. Furthermore, recent headlines regarding cyber-security and Chinese telecoms’ perceived connections with China should increase requirements for secure network access (enterprise customers, virtual private network) and specifically NVTL’s MiFi Mobile Hotspots.    

 

  • Limited Downside, Estimated ~$3.50 based on sum of the parts: Netgear’s (NTGR) comparable acquisition of Sierra Wireless’ (SWIR) Air Card at 0.58x of Revenues ($144M Purchase Price / $247M Revenue = 0.58x) places a downside valuation on NVTL’s MiFi Mobile Hotspot business of 82M (see table below; to get a "downside-case" revenue estimate, we  1) reduce LTM revenue of $238M by $50M to reflect what would happen if a comparable competitor to ZTE re-emerged, then we 2) apply ~25% discount to the comparabke 0.58x multiple). If we assume zero value for Modems and Embedded Modules and 1.0x of M2M LTM revenue of 33M (the equivalent valuation to SWIR pure-play ~$400M market cap / ~$400M LTM revenue excluding Air Card), NVTL would be worth ~$115M (82M + 33M) or ~$3.40 per share. There is also net cash that we will also ignore in the downside case assuming that it will be used to fund operations: NVTL has no liquidity issues (53M Net Cash) and 1Q13 annualized cash burn of ~25M could support 2 years of zero revenue growth and zero benefits from corresponding cost initiatives (R&D discussed in “Catalysts & Opportunities”). Between May 2012 (1Q13 earnings) and May 2013 (1Q13 earnings) the stock traded between lows of $1.20 to $2.50. At the trough in 4Q12, NVTL was annualizing at ~40M cash burn without a clear path to cost initiatives or revenue growth in Mobile Hotspot or M2M.
Downside Valuation: % of Revenue   LTM Rev 2H12 Adj. Adj. LTM Comps Discount Stressed Value
MiFi Mobile Hotspot   238.0 (50.0) 188.0 58% (25%) 44% 81.8
Modems (USB, PC Card)   40.0              -   40.0              -                -                -                -  
Embedded Modules   19.0              -   19.0              -                -                -                -  
M2M   33.0              -   33.0 100% 0% 100% 33.0
NVTL Comps Valuation   330.0   280.0       114.8
Per Share               $3.44

 

 

Business Overview:

NVTL is a leading provider of wireless broadband access solutions for the mobile communications markets. Products include Mobile Hotspots, USB modems, Embedded Modules for M2M and mobile computing OEMs, other M2M asset management devices, and communications and applications software. ~93% of revenue in 2012 and 2011 were to customers in the US and Canada, and VZ accounted for 58% and 51% of NVTL revenue in the same period. The primary product is the MiFi brand of Mobile Hotspots, which was invented by NVTL and first deployed in May 2009.      

  • Mobile Hotspots: the MiFi Mobile Hotspot is NVTL’s flagship product and continues to gain acceptance as a standard connectivity option for Wi-Fi-enabled devices by connecting to a wireless network and creating a secure Wi-Fi signal that can connect as many as 10 devices simultaneously. MiFi Mobile Hotspots accounted for 72% and 63% of 2012 and 2011 revenues, respectively. Management believes that Mobile Hotspots are one of the most profitable product lines and fastest payback periods at VZ.  We project this segment to grow 15% per annum over the next two years.

 

  • Modems & Embedded Modules: USB and PC-Card Modems accounted for 11% and 20% of 2012 and 2011 revenues, respectively, and Embedded Modules were 5% and 4% during the same period. Both categories provide wireless access to broadband networks. During 2012, profit projections did not materialize for Embedded Modules (PC OEM) and management decided to exit this business and reallocate resources to M2M. 2012 combined revenues were 190M lower at 65M vs. 2009 peak revenues of 255M in 2009.  We project Modem revenue growth of 10% per annum over the next two years.  We also project zero revenues from Embedded Modules going forward given the exit.         

 

  • M2M: the company entered the M2M market in November 2010 with the acquisition of Enfora. NVTL’s focus in M2M is within four verticals of “Asset Management”: Commercial Telematics, Asset Tracking (fleet management), Aftermarket Consumer Telematics (insurance services, systems integrators for vehicle services), and Fixed Telemetry (video surveillance, digital signs, point-of-sale machines). M2M accounted for and 11% of 2012 and 2011 revenues, respectively. Please refer to SWIR, Gemalto, Telit, Numerex (NMRX), or Fleetmatics (FLTX), among others, for further details of M2M market potential and applications. We project this segment to grown 17.5% per annum over the next two years. 

See the following two tables for the historical and projected revenue build and summary financials (note that we assume that NVTL will achieve its targeted gross margin of 23%):

NVTL REVENUE BUILD

 

2009

2010

2011

2012

2013-E

2014-E

2015-E

Net Revenue: Segment

             

 

Mobile Computing

 

337.4

332.5

358.1

312.5

323.1

368.0

419.3

M2M

 

             -  

6.5

44.8

31.8

40.8

48.0

56.4

NVTL Net Revenue

 

337.4

338.9

402.9

344.3

364.0

416.0

475.7

 

               

 

 

MOBILE COMPUTING

 

 

 

 

 

 

 

 

 

Mobile Computing Contribution:

             

 

 

% of NVTL - MiFi Mobile Hotspot

 

24%

49%

63%

72%

75%

75%

76%

 

% of NVTL - Modems (USB, PC Card)

 

50%

46%

20%

11%

11%

10%

10%

 

% of NVTL - Embedded Modules

 

26%

3%

6%

8%

3%

3%

2%

 

% of NVTL Mobile Computing

 

100%

98%

89%

91%

89%

88%

88%

 

         

 

   

 

 

$M - MiFi Mobile Hotspot

 

81.0

166.1

253.8

247.9

272.4

313.2

360.2

 

$M - Modems (USB, PC Card)

 

168.7

155.9

80.6

37.9

39.7

43.7

48.0

 

$M - Embedded Modules

 

87.7

10.5

23.7

26.7

11.1

11.1

11.1

 

$M Mobile Computing

 

337.4

332.5

358.1

312.5

323.1

368.0

419.3

 

         

 

   

 

 

Mobile Computing Revenue Build:

       

 

   

 

 

% Y/Y - MiFi Mobile Hotspot

   

105.1%

52.8%

(2.3%)

9.9%

15.0%

15.0%

 

% Y/Y - Modems (USB, PC Card)

   

(7.6%)

(48.3%)

(53.0%)

4.8%

10.0%

10.0%

 

% Y/Y - Embedded Modules

   

(88.1%)

126.7%

12.7%

(58.6%)

0.0%

0.0%

 

% Y/Y - Mobile Computing

   

(1.5%)

7.7%

(12.7%)

3.4%

13.9%

14.0%

 

         

 

   

 

 

$M Y/Y - MiFi Mobile Hotspot

   

85.1

87.7

(5.9)

24.5

40.9

47.0

 

$M Y/Y - Modems (USB, PC Card)

   

(12.8)

(75.3)

(42.7)

1.8

4.0

4.4

 

$M Y/Y - Embedded Modules

   

(77.3)

13.3

3.0

(15.7)

0.0

0.0

 

$M Y/Y - Mobile Computing

   

(5.0)

25.6

(45.6)

10.6

44.8

51.3

 

               

 

 

M2M CONTRIBUTION

 

 

 

 

 

 

 

 

 

M2M Contribution:

             

 

 

% of NVTL - M2M

 

             -  

1.9%

11.1%

9.2%

11.2%

11.5%

11.9%

 

$M - M2M

 

             -  

6.5

44.8

31.8

40.8

48.0

56.4

 

         

 

   

 

 

M2M Revenue Build:

       

 

   

 

 

% Y/Y

 

             -  

             -  

590.9%

(29.0%)

28.5%

17.5%

17.5%

 

$M - Y/Y

 

             -  

             -  

38.3

(13.0)

9.1

7.1

8.4

 
 
FINANCIAL SUMMARY   2009 2010 2011 2012 2013-E 2014-E 2015-E
  NVTL Net Revenue   337.4 338.9 402.9 344.3 364.0 416.0 475.7
                   
  - Cost of Revenue   (249.8) (272.6) (318.3) (271.8) (287.4) (320.3) (366.3)
                   
  Gross Profit   87.7 66.3 84.6 72.4 76.6 95.7 109.4
  % Margin   26.0% 19.6% 21.0% 21.0% 21.1% 23.0% 23.0%
                   
  - R&D   (44.9) (48.9) (61.4) (60.4) (49.8) (49.8) (49.8)
  - Sales, Marketing   (19.9) (21.0) (29.8) (27.5) (23.0) (23.0) (23.0)
  - G&A   (20.2) (21.2) (21.6) (22.7) (23.1) (19.0) (19.0)
  - Goodwill & Intangible Impairments                -                -              (3.3)          (49.5)              -                -                -  
  - Amort of Purchased Intangibles                -   (0.2) (2.2) (1.1) (0.6) (0.6) (0.6)
                   
  Operating Income   2.8 (25.0) (33.7) (88.7) (19.9) 3.3 17.0
                   
  + Int Inc                -                -                -               0.3 0.1              -                -  
  Other   1.7 (0.6) (0.7) (0.2) (0.1)              -                -  
                   
  Pre Tax Earnings   4.4 (25.6) (34.4) (88.7) (19.9) 3.3 17.0
                   
  - Tax   (0.5) (7.9) 9.5 (0.6) 0.1              -   (6.4)
  Norm. Tax Rate %                -                -                -                -                -                -   (37.5%)
                   
  NET INCOME   3.9 (33.5) (24.9) (89.3) (19.8) 3.3 10.6
  Per Share   $0.13 ($1.06) ($0.78) ($2.72) ($0.59) $0.10 $0.32
                   
  FD Shares   31.2 31.5 32.0 32.9 33.7 33.7 33.7
                   
  EBITDA                
  Adj EBITDA Build:                
  Net Income   3.9 (33.5) (24.9) (89.3) (19.8) 3.3 10.6
  + Tax   0.5 7.9 (9.5) 0.6 (0.1) 0.0 6.4
  +/- Other   (1.7) 0.6 0.7 0.2 0.1 0.0 0.0
  +/- Int Inc                -                -                -              (0.3) (0.1) 0.0 0.0
  + Goodwill & Intangible Impairments                -                -               3.3           49.5              -                -                -  
  + D&A, Incl "Purchased Intangibles"   13.0 11.7 17.9 12.3             9.2 9.0 9.0
  - Disposal of Fixed Assets              (0.0)              -                -                -                -                -                -  
  + Bad Debts   0.0 0.1 0.0             0.4              -                -                -  
  + Inventory Provision   2.3 1.9 0.7             2.8              -                -                -  
  + Stock Comp   6.9 6.5 6.0 7.5             3.9 4.0 4.0
  + Severance                -                -                -   0.9             0.7              -                -  
  Adj EBITDA   25.0 (4.8) (5.9) (15.2) (6.1) 16.3 30.0
  % Margin   7.4% (1.4%) (1.5%) (4.4%) (1.7%) 3.9% 6.3%
                   
  FREE CASH FLOW                
  Free Cash Flow Build:                
  Adj EBITDA   25.0 (4.8) (5.9) (15.2) (6.1) 16.3 30.0
  - Cash Interest              (0.0)            (0.2)            (0.0)              -                -                -                -  
  - Cash Tax              (0.3)            (0.3)            (0.1)              -                -                -              (6.4)
  - Capex              (5.8)          (10.8)            (6.0)            (4.5)            (4.4)            (6.0)            (6.0)
  Free Cash Flow   18.9 (16.1) (12.0) (19.7) (10.5) 10.3 17.6
  Per Share   $0.56 ($0.51) ($0.36) ($0.59) ($0.31) $0.30 $0.52
 

 

Catalysts & Opportunities:

  • EBITDA Growth and Free Cash Flow Break-even (High Probability / High Impact): the stock price followed company fundamentals on a downward trend beginning in January 2011 but the company should achieve cash flow break-even either in 2Q13 or 3Q13 with increasing revenues. If revenues do not materialize, we expect management to cut costs to achieve cash flow break-even by year end. With $53M of Net Cash at 3/31/13 and market cap of $135M, the stock has re-rated during 2Q13 in anticipation of improving fundamentals. Upside from current market valuation should be supported by growth in EBITDA and free cash behind gaining/re-capturing market share in Mobile Hotspots (see “Investment Thesis” above), M2M growth (see bullet below), R&D cost initiatives, and potential product wins and cyclical pick-up in the Modems business.

 

  • No Cash Taxes for at least 3-5 Years: NVTL has gross NOL carry-forwards of $91M with a full $64M valuation allowance against all Federal, State, and Canada NOLs. We do not assign any value currently to the tax asset, but this could potentially increase NVTL’s book value by $64M (or $1.90 per share) if this reverses.   

 

  • M2M Growth Story (High Probability / Medium Impact): ever since the Enfora acquisition in late 2010, NVTL’s M2M business has under-performed relative to product launches (late to 3G from 2G platform) and negatively skewed profitability with excess SGA related to product sales and R&D. 1Q2013 revenue increased 50% Q/Q (10.3M from 6.8M in 4Q2012) and with industry growth rates of 15-20%, proven technological know-how, and ~40M annualized revenue base (versus SWIR 10X larger revenue base), it is reasonable to assume NVTL at least participates in the 15-20% growth and resulting overhead absorption and operating leverage. In addition, this could slowly change investor perception of NVTL from a “Communications Equipment Supplier” to a higher-growth story around “The Internet of Things” (as termed by SWIR management).    

 

  • Patent Infringement Lawsuit VS ZTE Corp (Low Probability / High Impact): we currently attribute no value to the ZTE patent infringement lawsuit and management does not provide any quantitative metrics. We believe this could potentially result in a $50-100M cash settlement ($1.50 to $3.00 per share). 

 

Valuation:

  • $7.50 price target is based on an equal-weighted EV/EBITDA, P/FCF and Revenue Multiple Comps: we believe 6x EBITDA and 15x Free Cash Flow are comparable industry multiples for NVTL and “Communications Equipment”. We define Free Cash Flow as EBITDA less Cash Interest less Cash Tax (pro forma fully taxed at 37.5%) less Maintenance Capital Expenditures. As mentioned above, we do not attribute any value to the company’s NOLs; however, under EV/EBITDA valuation, one could include some present value calculation of the $64M valuation allowance over some period and include as a pro forma cash adjustment. For example, assuming 8 years at 12% WACC and $8M cash benefit per year, the Present Value would be ~$40M ($1.20 per share). Regarding the 15x Free Cash Flow multiple, we assume NVTL’s multiple to be based a fully-taxed amount with a tax rate of 37.5%, (although NVTL is not actually paying any cash tax for the next 3-5 years. Our 2015-E projections result in $6M ($0.18 per share) of cash tax that will not be paid.  See the following table for the build-up of the EBITDA and FCF-based valuations as well as a sum of the parts based upon revenue multiples:
 
CAPITALIZATION   VALUATION & PRICE TARGET
Stock (7/1/13)   $4.06       2015-E EBITDA
Diluted Shares   33.7       NVTL 2015-E Adj. EBITDA (M)     30.0
MARKET CAP (M)   136.9       (x)          6.0x
            EV (M)         180.2
    3/31/13 (Sources) 12/31/14-E              
+ ST Margin Loan Facility   4.8              -   4.8   - Net Debt / + Net Cash (M)     61.2
- Cash, 3/31/13   (18.3)              -   (18.3)              
- ST Securities, 3/31/13 Incl Restricted   (30.0)              -   (30.0)   Equity Valuation (M)       241.4
- LT Securities, 3/31/13   (9.9)              -   (9.9)   Price Target, EV/EBITDA     $7.16
- 2Q:4Q13-E FCF / + Burn                -   2.3 2.3              
- 2014-E FCF                -   (10.3) (10.3)   2015-E FREE CASH FLOW (Fully Taxed)
NET DEBT (CASH)   (53.3) (7.9) (61.2)   NVTL 2015-E FCF Fully Taxed, Per Share   $0.52
            (x)          15.0x
EV (M)   83.6       Price Target, P/FCF       $7.85
                       
EV / 2015-E EBITDA   2.8x       COMPARABLES
            % of Revenue:   LTM Rev. Multiple $M
            MiFi Mobile Hotspot   238.0 0.58x  138.0
            Modems (USB, PC Card) 40.0 0.25x  10.0
            Embedded Modules   19.0 0.25x  4.8
            M2M     33.0 1.0x  33.0
            Segment Valuation       185.8
                       
            - Net Debt / + Net Cash     61.2
                       
            Equity Valuation       247.0
            Price Target, Comparables     $7.33
 

Key Risks:

  • Lack of Demand for Mobile Hotspots: any alternative technology or customer habits to access wireless broadband networks could decrease demand for Mobile Hotspots, NVTL’s primary product. For example, enhancements to battery life or network security access, both frequently cited as demand drivers for Mobile Hotspots, could maintain status quo with wireless connectivity via laptops or phone. Wi-Fi city-wide access for free or for subscribers (see recent announcement from Google, Time Warner Cable, and Cablevision, among others) would also lower demand.

 

  • High Customer Concentration: VZ has been >50% of NVTL’s revenue since 2010 and will likely remain a major customer. Any changes to VZ’s policies and marketing strategies (subsidies, trade-ins, data plans/pricing) relating to their 4G LTE platform (or future roll-outs) could significantly impact NVTL’s MiFi Mobile Hotspots franchise.

 

  • ·Competition & New Product Cycles: every technology company is at risk of missing the next product cycle and NVTL is no different with Mobile Hotspots. ZTE and SWIR (NTGR acquired SWIR’s Air Card in April 2013) have been formidable competitors and carriers always prefer dual suppliers; however, NVTL’s patent portfolio provides a significant barrier to entry. The company currently owns 47 patents and has an additional 55 under application. NVTL has stated that they believe SWIR has also infringed on their patents but currently a lawsuit is only directed at ZTE because of clearer violations.

 

  • M2M Execution + Unwillingness to Rationalize R&D: NVTL is still in the early stages of M2M product sales (~40M annualized revenue versus SWIR ~400M excluding Air Card acquired by NTGR) and just recently transitioned from a distributor model to direct sales (66% of 1Q2012 M2M revenue versus 38% last year). As such, there is significant investment required in R&D and SGA before realizing any revenue. As discussed above, NVTL’s 2012 $60M R&D on a $340M revenue-base is roughly equal to SWIR and NTGR, which had 2012 revenue of $640M and $1.3B, respectively. Management has a stated goal of 10% EBIT Margin and acknowledges they would evaluate cost initiatives if Mobile Hotspot and M2M forecasts do not materialize; however, any delays, unwillingness, or inability to rationalize R&D and SGA would result in negative EBITDA and further extend the free cash flow break-even thesis.

 

Disclosure

We make no claims, promises or guarantees about the accuracy, completeness or adequacy of the contents of this document and expressly disclaim liability for errors and omissions in the document.  We have no obligation to update this document.  We may change our position at any time without posting an update.  The views expressed here are merely the opinion of the author.  Readers should do their own research.


 

I do not hold a position of employment, directorship, or consultancy with the issuer.
Neither I nor others I advise hold a material investment in the issuer's securities.

Catalyst

1) EBITDA Growth and FCF break-even, 2) the M2M growth story and 3) potential for significant windfall from patent infringement lawsuit
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