Description

I expect Telit to be the target of a (potential) take-over battle starting over the next two weeks. Over the past few years, Telit has been gathering interest from various players and it looks like we are (finally) at the beginning of the end-game for Telit. After the 2017 mess and the subsequent restructuring, Telit is now cleaned up, focussed on generating cash and trading for ~5.5x 2020e ev/ebitda with net cash accounting for ~20% of the current enterprise value.

The purpose of this write-up is to flag the potential take-out of Telit which I expect will be very soon. I will provide a brief background on the events of the past years to give context to the current situation. I will not however discuss Telit’s products, markets and growth potential in detail; that is not the purpose of this write-up. I apologise if this write-up is short; this is my fourth write-up this year and my intention is just to share the opportunity.

Some background

Telit is a relatively large player in the Internet of Things (IoT) space. The IoT can simply be imagined as many connected devices (to each other and the internet) which allows assets/products/devices to be continuously monitored and data to be gathered centrally. This data can be analysed and used to improve the efficiency a company’s products and operations.

Telit’s revenues are generated with the sale of products and services. Product revenues make up the largest part of total revenues (~88%) and consist of the sales of communication modules; small modules that can be used to connect a device to the internet. If one would like to connect a refrigerator to the internet, a simple module would do the trick. Product revenues have relatively low gross margins, can be lumpy due to required certification by the network operators such as Verizon and AT&T and are dependent capex cycles, the roll-out of new technologies (eg 4G LTE, 5G) as well as the overall IoT market growth (the growth of ‘connected’ devices). This area of the IoT has been through a hype phase over the past years as mega-estimates of the amount of modules necessary in the IoT-world have been used to project huge TAMs. Companies and consultants regularly forecasted >25% CAGRs for a decade. In addition, many players branded their modules as ‘the best’ for a specific purpose (geolocation, temperature measurements, speed and volume of data, security, etc).

An interesting aspect of Telit has been its positioning. Telit (correctly) assumed that with such a huge growth of connected devices, the hardware itself would face massive cost pressures very quickly as the market would become commoditised. As such, Telit’s strategy was to be technology-agnostic, provide a wide gamma of solutions (modules) and focus on growing its services platform. In this respect, I believe this was the right approach; other companies failed to adapt and paid the price. One example is U-Blox (UBXN SW), which used to have some of the best positioning modules on the market. The company focussed on maintaining its lead in the GPS space and less on growing services. As competitors improved their products, the market commoditized quickly and U-Blox’s financials deteriorated fast in less than three years’ time.

The rest of the revenues are PaaS (Platform as a Service) revenues. Telit’s services  business enables companies to assess their installed module base via remote monitoring. The monitoring, collection and analysis of the data from the modules allows customers to have a better understanding of the performance of their assets and use this data to increase efficiency and output. The services business has several advantages compared to the product segment: There are no certification and manufacturing costs and a large part of these revenues are recurring. Services are growing well and are an important pillar of future growth. Gross margins are much higher and recurring revenues greatly improve visibility.

Telit appeared to be growing well up to 2017. I remember being positive on the outlook of the company based on its strategy (technology agnostic, aware of the quickly commoditizing market and focussed on growing services), the strong industry tailwinds and even positive comments from competitors (Gemalto, Sierra Wireless and U-Blox). Also, the competitive landscape seemed ‘ok’ as it appeared several companies would dominate and divide this fast growing market (ao Huawei, Gemalto, Sierra Wireless and U-Blox). I assumed that given security issues no single player would be allowed to control the market and it would also be difficult for new competitors to enter the market as scale was a big requirement.

However, after a lot of research I decided to pass and keep Telit on a watchlist. Several things raised flags:

• Very bad communication of the management with the market. The CEO was solely focussed on growth, reinvesting all that the company earned into growth to capture market share and acquiring small companies to expand the technology portfolio. I have no issues with reinvesting all that a company earns, though the company would regularly miss guidance - particularly on the cost side - as management decided ‘to accelerate growth’.
• Aggressive accounting, mainly related to R&D. The company started to capitalise more and more of its R&D costs. Again, no issues here, as long as you communicate (which the company didn’t do).
• Organic top-line growth was difficult to determine, mainly clouded by acquisitions.
• As a consequence of the above, it appeared the company was not generating cash. I remember spending several hours trying to split capitalised R&D, amortisation, acquired intangibles and ‘one-offs’ to figure out how much cash the company was actually generating. Not much it seemed.

Normally after the above ‘flags’, I would pass and move on. What intrigued me here is that most competitors I reached out to spoke well of Telit’s products and strategy. It seemed that this company truly had a good product offering.

A lot changed after 2017. All the above ‘flags’ came together during H1 2017 and the company reported very bad results for the first half. The market tolerated the aggressive growth and accounting practices for some years, until the H1 2017 results. In addition to the bad results, a scandal ensued with the CEO as it was uncovered that Oozi Cats was allegedly the same person as Uzi Katz, who was indicted for property fraud in the U.S. in the 1990s. It was rumoured in the press that the CEO and his wife have been fugitives from the U.S. for over 20 years. One couldn’t make this stuff up:

https://www.ft.com/stream/67f098b7-f6b3-4366-859e-bb986220d89d

https://www.bloomberg.com/news/articles/2017-08-14/oozi-cats-or-uzi-katz-from-fugitive-to-tech-ceo-and-back-again

This obviously caused a lot of turmoil in the company and the market. After an initial complete overhaul of the shareholder base, Telit’s stock price went nowhere for 3 years.

Where are we now

To make a long story short, a lot has changed over the past three years:

• Both boards have been overhauled and renewed.
• Investigations have been initiated (LSE, FCA) and closed.
• Assets have been sold. In 2018, Telit agreed to sell its automotive business for $105m to TUS International, listed in Hong Kong. The sale was completed in early 2019. Telit now has a net cash position.
• The new management has increased and improved communication.
• The biggest change has been the focus on cash generative growth, with a strong focus on cost control. The company’s main KPI is now ‘Profit in Cash’ defined as ‘Adjusted EBITDA less development costs capitalised, less capital expenditures, less lease expenses in cash’.
• In addition, the shareholder base has been completely overhauled and basically all analyst coverage has been dropped.

It appears that, fundamentally, the company has been able to withstand the difficult times and is back on the right track. Telit has continued to win projects and certifications. According to (new) management, Telit’s customer base has been loyal over the past years. Looking at the recent results, the company seems to be on path to start growing again as of next year – though this time profitably. Telit should be able to generate >$40m ebitda in 2020 and grow this double digit p.a. over the next few years. Given increased expected spending from telco’s during H2 this year and 2021, growth in both products and services and strict cost control, it is not a stretch for Telit to generate ~$50m ebitda in 2021. The company has a cash balance of ~$90m (on a market cap of $280m), net cash of ~50m and is trading at ~5.5x 2020e ev/ebitda.

Recent events

The name ‘Telit’ is tainted in the market. Given the previously described history, it is no surprise that very few people care about the stock. It has been my opinion that the best way forward for Telit is to be acquired. It should not come as a surprise that this now indeed seems to be the way forward. After a long period of restructuring, Telit has now cleared all investigations, has a clean balance sheet, new management and is on track to profitable growth.

There has been a lot of movement in the shareholder base recently and suddenly. Lots of new shareholders and increased buying from existing shareholders. The trigger has been the announcement on Nov 3:

Telit Communications PLC (“Telit” or the “Company”) notes the recent media speculation and confirms that it has received a preliminary approach from DBAY Advisors Limited, (“DBAY”) regarding a possible offer for Telit to be made by funds under the management of DBAY. Telit has also received a preliminary approach from Lantronix Inc, (“Lantronix”) regarding a possible offer for the Company (the “Lantronix Proposal”). The Lantronix Proposal was considered by the Board of Telit, together with its financial adviser, Rothschild & Co, and rejected. However, the Company remains in discussions with Lantronix to explore a possible transaction which could be in shareholders’ interests. The consideration for any offer, if made, is likely to be Lantronix shares.

Interesting to note that DBAY is a new shareholder and has amassed a 15% stake over the past weeks. In addition, Run Liang Tai (who had a 14% shareholding acquired after the 2017 debacle) has very recently started to increase its stake and is now also a ~15% shareholder. Also to note, it has been rumored various times over the past years that Sierra might be interested as well in Telit. So it appears we have a combination of strategic and financial players interested in Telit.

The reason I believe the next weeks will bring more clarity is the last part of the Nov 3 release:

In accordance with Rule 2.6(a) of the Code, DBAY and Lantronix are each required, by not later than 5.00 p.m. on 1 December 2020, to either announce a firm intention to make an offer for the Company in accordance with Rule 2.7 of the Code or announce that they do not intend to make an offer for the Company, in which case the announcement will be treated as a statement to which Rule 2.8 of the Code applies.

Management indicated that the Lantronix proposal has been rejected, but that the company remains in discussion. It is clear (and obvious) that Telit is open for an exit.

I generally don’t invest in m&a driven special events, but I believe the risk/reward in this case to be compelling. The downside is that nothing happens, the share price might drop 10-15% and you have a company that seems again back on track to grow and generate cash, with a very strong balance sheet and an unimpressive valuation. In addition, I believe Telit now has a strong shareholder base as all who wanted to sell have sold in recent years. The upside is that a deal materializes in the very near term.

Catalyst

Dec. 1 deadline to announce firm offer