Description

Sierra designs and sells hardware and services for wireless connectivity, focused on enterprises and industrial internet of things (IoT). Despite significant end-market tailwinds and a successful transformation to a healthier business mix, SWIR remains misunderstood by investors. This is partially driven by hardware analysts and investor not liking (or understanding) the value in having both hardware and connectivity bundled. We expect a new CEO at SWIR will enhance the current strategy by focusing on operational excellence and increased profitability. With net cash on its balance sheet and a talent packed board of directors, SWIR is primed for operational, financial, and further strategic improvements in the coming years.

SWIR has a long history as an electronic connectivity designer, known for its high-quality technology. Currently, the company reports in two divisions – Enterprise Solutions which designs and sells products such as routers and gateways for customers such as utilities, emergency services and government services. These products are technologically advanced, and SWIR is a leader in their end markets, resulting in strong gross margins of ~50%. Customers in this segment value reliability and frequently want to only use SWIR products. As the company has been noting, demand in this segment remains robust and is expected to continue for the foreseeable future.

IoT Solutions designs and sells modem modules for industrial solutions. The module market is growing rapidly but is competitive, with recent Chinese startups such as Quectel entering the market, and results in lower gross margins for this segment. However, hardware margins are partially offset by continued growth in higher margin connectivity and services, with notable success in selling customers a full solution of hardware, connectivity, and services. In particular, the company is seeing early signs of success in selling its Octave product where industrial companies can purchase end-to-end solutions for asset monitoring. We expect this end-market to keep up its frenetic growth pace.

Current CEO Kent Thexton will be retiring in August. Since becoming CEO in November 2018, Kent has tapped his venture capital business acumen to successfully reposition the company from a hardware centric to a hardware/connectivity solutions business. This entailed building (and buying) a best-in-class connectivity platform that relies on 600 partners and works in 190 countries. Kent’s vision is to bundle connectivity and services with hardware purchases. This is a differentiator – few companies are positioned to compete with SWIR in selling both hardware and connectivity. While Thexton has done an excellent job re-positioning SWIR for accelerated growth, the company has struggled to get its cost structure in-line with peers. We suspect this is major driver for the announced CEO change. On July 12^th, the company announced that Phil Brace will join as CEO. Brace appears to have extensive experience with both hardware and software businesses, and we look forward to hearing his vision for SWIR soon.

Currently SWIR has a ~$125m revenue run rate business from connectivity and services (which it refers to as recurring revenue), with a goal to hit $400m in the next 3 years. Despite this progress and future targets, most investors think of SWIR as a hardware company. We think the company can do a better job highlighting the value of its growing and profitable connectivity business. Cerberus, a large private equity fund, is attempting to use its SPAC vehicle (an empty vehicle with only cash) to purchase KORE, a pure play IoT connectivity company. KORE has revenues of ~$200m vs. SWIR’s connectivity of $125m and KORE has some margin advantages that comes with scale. However, KORE is growing at half the rate (or less) vs SWIR connectivity. The valuation for KORE, assuming the deal closes, suggests 15.7x 2022 estimated EBITDA and ~27x 2022 estimates free cash flow. While we do not take our valuation cues from SPACs, KORE valuation is proof SWIR needs to do a better job explaining its business mix.

Thexton also oversaw the sale of the company’s low margin automotive division during 2020. From a strategic perspective the automotive modules segment was a China based business that was a) competitive and b) without the ability to bundle connectivity. Essentially, this segment was a dead end and did not fit into the business portfolio. The company received an excellent price and the proceeds allowed SWIR to enhance its balance sheet, which now has net cash of $1.80/share.

In addition, SWIR has one of the strongest boards for a company of its size. Jim Anderson was nominated to the board in April 2020 as part of an agreement with an activist investor in SWIR. Jim has been the CEO of Lattice Semiconductor since September 2018 and shares of Lattice has increased during his tenure from ~$8 to over $50 today. In March 2020, SWIR appointed Greg Waters to the board. Greg was former CEO of Integrated Device Technology which was acquired in April 2019 for $49/share, up from ~$10/share when Greg was appointed CEO in 2014. The other board members have strong track records of value creation and industry leadership.

We believe SWIR is materially underearning with its current cost structure. Furthermore, the core business should grow at double-digits for the next few years led by end markets that are growing volume at 25%+. Even if the company falls short of its ambitious target of $400m of recurring revenue by mid-2024, we envision SWIR generating free cash flow of ~$2.00/share. We believe that will be worth $40/share plus over $5/share in net cash. This does not include upside from a potential US ban of Chinese modules, something some sell-side analysts have recently touted. Overall, we acknowledge there are unknowns and risks to execution, but we see limited downside and lots of paths to upside.

Catalyst

New CEO begins to realign cost structure

Investors focus on hardware + connectivity/software dynamic