Novatel Wireless: Fundamentally Flawed Business Plan, Lockup Release Lather Up This Soap Opera

by Sonya Colberg, Senior Investigative Reporter - 2/9/2015 9:45:11 AM

Novatel Wireless (MIFI) rose from a virtual bodice-ripping B-grade soap opera star into a rather proper Wall Street darling in three months, with shares bursting to ~$5.50 for more than a 78 percent gain.

But while Novatel has recently shed some drama (read the steamy shareholder letter here), the company remains fundamentally flawed.

The wireless solutions technology provider primarily sells pocket-sized wireless modems to allow Internet access anywhere and also machine-to-machine modules.

But we don’t believe this San Diego, Calif.-based company is likely to return the love investors have thrown at it recently.

For other viewpoints on Novatel, click on this link. Read on to find out why we consider Novatel risky both now and later.

*Why Novatel’s biggest revenue-generator is unlikely to reach expectations.

Novatel is focusing on the MiFi system - a Wifi hot spot provided through a wallet-sized box that consumers on the go can use to access the Internet with their mobile gadgets.

“They’ve been doing that for a long time. It’s a brutal business. It’s always been brutal,” said a tech analyst who requested anonymity. “The margins are terrible.”

In fact, the product produces less than 11 cents to a little over 20 cents for each dollar sold. The margins improved last quarter – special thanks go to a $2.9 million inventory write-down and selling $2 million in old inventory at near cost.

Indeed, Novatel must hate having a bunch of its obsolete China-and-Thailand-made inventory sitting around. Yet it says “increased competitive pressures” may force more of these write-downs.

With these historically bad margins and declining revenue grabbing Novatel by the throat, some leaders wanted to sell the MiFi division last spring, according to sources.

But, of course, the spinoff didn't happen.

*No buyers for MiFi is spooky enough. But there’s more.

Then, with no other company apparently wanting MiFi, miserable share prices and a poorly settled class action lawsuit, activist shareholders lobbed a rip-roaring fiery letter alleging Novatel had been mismanaged. The company booted executives and directors and installed new ones, and even replaced its old “NVTL” stock symbol with “MIFI.”

Emerging from this soap opera, activist shareholder/interim CEO Alex Mashinsky became the permanent CEO. Fellow activist shareholder Richard Karp joined him on the board of directors.

The leadership that emerged from the summer of 2014 bloodbath is now trying to pick up the sagging MiFi business responsible for nearly 79 percent of Novatel’s sales.

But the results have been disappointing.

Last quarter, revenue from MiFi dropped a blistering 59 percent. Yes, compared with a year ago, MiFi revenue is a whopping $49 million lower. Net losses rose an unspeakable 58 percent to $8.8 million.

Results for the past nine months were slightly worse. So why did the declines happen?

SEC filings blame “lower sales of mobile broadband devices,” and the M2M result wasn’t better due to “decreased sales of embedded products to M2M customers.” This shows customer acceptance problems.

SEC filings say earlier low sales were “caused by increased market competition at our largest customer” which is Verizon. And by “lower average sales prices.” This points to the risks - largely beyond the new management’s control - of Novatel’s reliance on one customer, as well as the bargain-basement prices caused by waning interest in Novatel’s product.

*Brutal competition, market decline expected

So Novatel’s losing the advantage it once enjoyed because it got to the MiFi (or USB modem dongle) party early. Now, the party’s wild and “extremely competitive” – roughly 90. These include Sony Mobile, Nokia and Apple.

Additionally, this market is falling, according to Strategy Analytics research.

The mobile broadband modem market fell 17 percent in 2013. And the 2014 decline is expected to be even worse – a 24 percent drop. Though mobile hotspot routers were considered the bright point, overall industry sales are predicted to plunge to half the 2010 levels.

So Novatel and its market rivals will chase fewer and fewer dollars.  

*Most daunting: Hotspot tech already built in.

An analyst who said he tossed out his MiFi box some time ago pointed to another major threat to Novatel.

IPhone and other smartphone owners are beginning to realize that they already have cheaper, simpler access to hotspots built right into their phones. They don’t need Novatel.

So smartphone users can turn on their phone’s hotspot feature to get free Internet access to the phone, laptop, iPad or other gadget.

In comparison, the MiFi hotspot costs ~$50-$200, and the carrier charges users about $50 extra per month. Why would customers pay extra for something when they’ve already got the feature built-in?

*Competition in the overseas market

With little wiggle room left for MiFi in the US market, Novatel is looking overseas.

“So we want to go from basically 90% of our sales in North America to something less than 70% of sales. So and to get there, we really need to have some substantial wins in both Europe and South America and other markets,” Mr. Mashinsky told analysts at the last earnings conference call.

He also noted that “these (overseas) things take a little bit longer both to win and to deploy.” The problem is that major competitors are already digging into that overseas market. 

Strong rivals working in the overseas market include Chinese vendors ZTE Corp. ($31 billion revenue) and Huawei, ($47 billion revenue). Another US-based public company targeting sales in other countries is Digi International (DGII), a company that isn’t blowing up the sector but at least isn’t as weak as Novatel.

 

Novatel

Digi

Sierra

CalAmp

Cash Flow     

-$31.9m

+$7.5m

+$48.7m        

+$24.3m

EBITDA 

-$21m  

+$4.7m         

+$12.7m

+$30m

Net Income

    -

    -

      -

  $  4m

Net Loss

- $8.8m

 -$0.3m

 - $1.7m

      -

*And more. Novatel lags behind M2M competitors

Novatel showed a slight increase in machine-to-machine, M2M, revenue last quarter. But M2M brings in less than 22 percent of the revenue.  And this is just too insignificant to really help declining MiFi sales and poor margins, especially since Novatel appeared too late and too small.

Much of M2M is owned by Sierra Wireless (SWIR) (see financials highlighted in the chart above). Sierra Wireless spun off the equivalent of Novatel’s MiFi business, “AirCard,” in 2013 and has been gaining in M2M ever since. Sierra hyped a $90 million M2M deal last December, spurring the share price 48 percent to $48. Novatel investors should note how Sierra got ahead of itself as shown by the fallout when quarterly results released last week failed to live up to the hype. Within hours, the share price tanked to a more realistic $34 because the market expects far superior results and guidance here.

Other rivals include Gemalto, Telit and Freescale Semiconductor (FSL). Yet another big player is long-time Oxnard, Calif.-based CalAmp (CAMP), with diversified products and $11 million in net income last year.

*Internet of Things competition

Novatel is also eyeing the Internet of Things market. Internet of Things, IoT, connects devices to address consumer and industrial goods such as smart appliances, smart watches and smart parking meters.

This is another market targeted by well-funded Sierra Wireless. Less established companies like Novatel would be hard-pressed to squeeze into this battlefield already dominated by the likes of Intel, Qualcomm and others. Intel Corp. just revealed a new platform that makes it easier for companies to use Intel products when they build smart products.

*Millions of Novatel shares loom. Overhang expires next month.

Besides the longer term risks, Novatel stock faces a challenge in less than 30 days.

Novatel touted a neck-saving ~$23.7 million investment by HC2 Holdings 2 just last September. Novatel issued 7.4 million shares of stock for just $1.75 apiece, preferred stock, plus warrants for 4.1 million shares.

The kicker: Time’s almost up on the stock warrants. Beginning March 8, with the right to exchange the warrants for stock at just $2.26 per share, HC2 can sell any or all of those 4.1 million shares.   

At today’s share price, selling all those cheap shares would give HC2 about $11 million. Two HC2 officers were installed on Novatel’s board and one would hope they would sell thoughtfully. But, with the allure of $11 million now versus the uncertainty of tomorrow, it makes sense to sell.

Indeed, more financial pressures are looming right around the corner. In just two quarters, Novatel is on track to burn through its $20 million in cash provided by HC2. So, Novatel’s likely to face the uncomfortable decision this year of accessing its revolving loan, other debt and/or issuing even more potentially dilutive shares of stock.

*Conclusion

Novatel’s biggest revenue-generator, MiFi, is fizzling against fierce competition in a shrinking market, plus smartphone owners who use their built-in hotspot feature instead of Novatel. And, though the company hopes its machine-to-machine service will help fill the gap, Novatel is way too far behind, too undifferentiated and too small to successfully navigate this highly competitive arena.

With Novatel desperately fighting to overcome a weak business plan – and facing next month’s unlocked cheap shares – we expect the stock to swoon as the drama drains from this soap opera and the story closes with a dull thud.

* Important Disclosure: The owners of TheStreetSweeper hold a short position in MIFI and stand to profit on any future declines in the stock price. 

Editor's Note: As a matter of policy, TheStreetSweeper prohibits members of its editorial team from taking financial positions in the companies that they cover. To contact Sonya Colberg, the author of this story, please send an email to  [email protected].

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