For most of the year, Sierra Wireless Inc. was one of Canada's best investing stories. Up more than 100 per cent, it was the best-performing stock in the S&P/TSX composite for much of 2017. The Vancouver tech company was showing strength in earnings, coupled with its sexy long-term story as a big player in the "Internet of Things," the trend that sees the connection and digitization of all manner of objects.
Alas, companies like that can easily get laid low, and that is what happened last week. Sierra Wireless announced third-quarter guidance that was just a hair below expectations, and said it would make a deal to bolster its IoT business that would regrettably dilute its earnings in the short term.
The harsh justice of the market: Sierra Wireless is down more than 20 per cent from a week ago. The decline has cut more than $200-million (U.S.) off its market capitalization, more than double the size of the deal.
Which, if you've got the nerve, means a buying opportunity.
First, a little bit about the company's recent trajectory. In June, 2015, I profiled Sierra Wireless as "Canada's purest play on the Internet of Things" and said it was ripe to climb from its $33 (Canadian) share price. Alas, a series of earnings disappointments sent it in the other direction entirely, and it bottomed out below $14 in February, 2016. Late last year, however, the company showed signs of a turnaround, and 2017 has been marked by doubled-digit sales growth and positive earnings surprises. Hence, the shares rocketed.
What did the company do to foul the narrative last week? It gave third-quarter earnings guidance of a range of 17 cents a share to 25 cents (U.S.) a share. The midpoint of that is 21 cents, which was 3 cents below analyst consensus, says Scott Searle of The Benchmark Co. LLC.
To whack the stock for this may strike you, appropriately I think, as a startlingly short-term way of thinking, but it's the way of the world in the universe of growth-focused tech investing. Bad news for existing holders, good news for those who might use the opportunity to buy in.
At the same time, Sierra Wireless made an opportunistic deal that won't yield immediate results. It will purchase Numerex Corp., an Atlanta-based IoT competitor that's trading at a multiyear low, says Daniel Kim of Paradigm Capital Inc. At its announced price, the deal is just an 8-per-cent premium to Numerex's most-recent close (and the decline in Sierra Wireless has sent the deal price near the company's 52-week low, something to keep an eye on).
The deal isn't supposed to close until January, 2018, and it will dilute Sierra Wireless's earnings per share (calculated in a manner other than with general accepted accounting principles) until at least 2019, the company acknowledges. (Mr. Kim estimates his 2018 EPS forecast goes from $1.13 to 79 cents with the deal.)
That's meaningful, and investors should compensate by knocking down Sierra's value. But by this much? At the current Sierra Wireless share price, the total value of the deal is about $90-million, less than half of the market value that's disappeared since last week. Now, buying Sierra Wireless shares is kind of like getting a discount, plus all of Numerex for free.
It's worth more than that. Let's look to a couple of the bulls, who have maintained their buy ratings in the wake of the quarter's news.
Canaccord Genuity Group Inc.'s T. Michael Walkley, who has a $30 (U.S.) target price, versus Thursday's close of $22.75, says the deal makes "strong strategic sense" and should actually increase Sierra Wireless' profit margins.
Richard Tse of National Bank Financial, who has a $32 target price, notes that the big appeal of Numerex is its recurring revenue – a holy grail of tech, where companies prefer customers who pay something every month or quarter, rather than buy one-off hardware or software projects every so often. Mr. Tse says Numerex should take Sierra Wireless's recurring revenue to 12 per cent of the top line, up from 4 per cent currently. Coupled with its higher profit margins, the Numerex business "should drive a re-rating in the name," he writes, which is Streetspeak for investors bidding up the shares to a higher price-to-earnings multiple.
In addition, he says, it offers some geographic diversification, as currently Sierra Wireless pulls in 70 per cent of its $800-million-plus in sales outside North America, while 95 per cent of Numerex's $65-million revenue comes from the United States.
Certainly, there is what we like to call "integration risk," the chance there's a problem merging Numerex into the larger company. But the sour reaction to this one-two punch has dented the shares far more than warranted. It's given investors a do-over on this long-term growth story.
David Milstead