The fifth iteration of wireless communications technology is looking like the most exciting one yet. Previous evolutions have brought us faster speeds and better connectivity. This latest revolution, known as 5G, could upend the way our economy and cities work forever.
5G technology is expected to deliver some pretty jaw-dropping improvements over the current 4G wireless standard. Download speeds are expected to improve up to 100 times over, coverage and availability could be pushed to 99.999%, latency could drop to a mere millisecond and energy usage could drop by as much as 90%.
But perhaps the biggest improvement is the number of devices that can connect to any given network simultaneously. 5G standards could allow hundreds of devices to connect to the same network without a noticeable drop in performance, paving the way for the internet of things (IoT), which means your car could talk to your smart home in the future and turn the lights on as you get home.
At the forefront of this revolution is a Canadian technology company that has cemented its position as a wireless tech leader: Sierra Wireless (TSX:SW)(NASDAQ:SWIR).
The company is the world’s top manufacturer of embedded machine-to-machine (M2M) modules and gateways. Its chips have been instrumental in cellular devices for the past two decades.
A chip manufacturer with decades of experience in wireless technology should benefit immensely from the rise of 5G technology — a market that’s expected to explode from US$5.53 billion in 2020 to an estimated US$667.90 billion by 2026. The problem is that Sierra has struggled to extract meaningful profits from these exciting changes in technology.
The challenge
Sierra’s biggest challenge is its razor thin margins. The equipment manufacturing side of the 5G tech revolution is incredibly competitive. Meanwhile, the higher margin enterprise business is a smaller portion of the company’s sales and the emerging IoT segment isn’t growing as fast as some would have expected.
All this has squeezed Sierra’s profits and growth throughout 2019, while investors have shaved off nearly a third of the company’s value over the past year. Sierra’s stock is currently trading at its lowest price since 2013.
The solution
Management appears to have a turnaround plan based on vertical integration. Rather than simply manufacturing and distributing wireless modules and gateways, the company now wants to also offer the software layer on top that helps companies manage all their devices remotely.
In other words, Sierra wants to transition to a subscription enterprise cloud service platform. That involves recurring revenues and fatter margins that should ultimately boost the company’s bottom line.
At the moment, recurring revenue is just $100 million a year. The company expects to double this by the middle of 2022 — and double it yet again to $400 million by the middle of 2024.
By changing the business model, Sierra’s management could convince investors to reevaluate the stock and price it like any other software-as-a-service (SaaS) corporation. SaaS businesses tend to trade at higher multiples and are generally less volatile than other tech businesses.
Bottom line
Sierra Wireless is already at the forefront of the 5G revolution. With its transition to software services, the stock deserves a richer valuation. Investors probably won’t have a better chance to get into this stock for cheap ever again.
