Sierra Wireless (NASDAQ:SWIR) has failed to live up to its massive potential, as its largest business — original equipment manufacturer (OEM) solutions — has hit a brick wall. The story was no different when it released its fiscal first-quarter results in early May. The Internet of Things (IoT) specialist saw a tepid annual increaseof just 2% in OEM solutions revenue, while gross margin in the segment fell nearly 3 percentage points.
But Sierra investors were a satisfied lot as the company showed that it has found new catalysts to offset the weakness in OEM solutions. In fact, Sierra’s overall revenue rose almost 16% year over year thanks to the massive growth in enterprise solutions and IoT services, two businesses that now account for nearly28% of its total revenue and look set to step on the gas.
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A closer look at the catalysts
Sierra’s enterprise solutions revenue shotup 35% annually to $29.2 million last quarter, drivenby strong demand from verticals including industrial, transportation, and energy.
For instance, demand for the company’s AirLink telematics solutions has been propped up by compliance-driven deployments, as fleet operators scrambledto meet new federal regulations. However, Sierra expects transportation demand to cool down in the second half of the year and return to normal levels, though there are other catalysts ready to fill in.
The company recently signeda deal in Sweden to supply its programmable gateways to industrial equipment manufacturer Atlas Copco, which will use Sierra’s modules to improve factory efficiency, reduce downtime, and carry out preventive maintenance on time. This contract could be a big deal for Sierra in the long run, as Atlas Copco is a global corporation with annual revenueof over $14 billion last year, and runsover 100 production sites in more than 20 countries.
More importantly, the company’s enterprise segment carries a much higher margin profile than the overall business. It reported a non-GAAP gross marginof 48.2% last quarter, far above Sierra’s overall gross margin of 33.4%.
On the other hand, Sierra’s IoT services revenue more than tripledto $22.5 million, primarily drivenby a full quarter of revenue from the recently acquired Numerex. But what’s remarkable is that this segment displayed terrific growth even on an organic basis. Excluding Numerex, Sierra’s IoT services revenue shot up almost29% year over year, while the non-GAAP gross margin stoodat an impressive 40.9% despite a one-time network upgrade cost.
Sierra’s IoT services business supplies cloud-based platforms to customers so that they can deploy and manage IoT applications. Demand for such IoT services should grow at a fast pace as more devices connect to the internet or each other. In fact, IDC forecasts that demandfor IoT software and services will increase at five-year compound annual growth rates of 16.1% and 15.1%, respectively.
Additionally, Sierra is witnessing strong cross-selling activity in the IoT services business. Over halfof the design wins that it landed in this segment originated from the enterprise and OEM solutions sales teams. The company claimed that it saw good customer acquisition activity in this segment last quarter, which, along with the strong traction in the enterprise business, allowed it to issue a solid forecast for the current quarter.
The midpoint of Sierra’s forecast indicates that its top line will grow nearly 15% in the second quarter, which means that the enterprise solutions and IoT services businesses will keep delivering.
What about the elephant in the room?
Sierra’s OEM solutions segment is its biggest source of revenue, supplying around72% of the top line. So it is important for this business to succeed to power the company’s long-term growth. The good part: Sierra is witnessing signs of a turnaround. It saw stronger design win activity in this segment last quarter, but more importantly, it has started deployment of its low-power wide-area (LPWA) network modules.
Japanese telecom provider KDDI will start deployingSierra’s gas smart meters by mid-2018. This will be the first deployment of the company’s HL78 LPWA modules that can support M2M connectivityfor up to 15 years. These modules are going to play an important role in IoT deployment, as they allow machines to communicate with each other for long periods of time thanks to their low power consumption.
Not surprisingly, the number of LPWA connections is set to go up from just 59 milliona couple of years ago to over 3 billion in 2025, providing yet another massive growth opportunity for Sierra.
So even the OEM business has catalysts that will eventually kick in and help turn this segment’s fortunes around. But investors might need to remain patient, as Sierra is struggling because of a shortagein component supply that has marred production. However, the company expects supply constraints to ease from the second quarter onward.
Patience will pay off for Sierra investors
The long-term outlook for Sierra Wireless is still bright given the industry it operates in. So it isn’t surprising to see consensus estimates suggest that its earnings could increaseat a CAGR of nearly 20% for the next five years. This makes Sierra a solid long-term bet given that it tradesat just 14 times forward earnings.