Europe is a very underfollowed market in the small-cap technology space. Investors in that region are more risk-averse than US investors and consequently, often shun potential technology investments. We have had great success finding unique technology companies at low valuations there. One example is Telit Communications (OTCPK:TTCNF) (TCM.LN), a company based in the UK that has important technology and trades at a discounted valuation. Telit surfaced on one of our valuation screens last spring as a stock with a low Enterprise Value to Revenue ratio. This valuation metric highlights companies that have the potential to be very cheap on a Price-to-Earnings ratio if they can expand their margins in a meaningful way. We did our due diligence on Telit and came away impressed with its business model, execution, and management team, driving our decision to invest in the company.
Telit is an important player in the burgeoning Internet of Things (IoT) market. The Internet of Things envisions a web of connected devices each providing data to a central repository where the data can be analyzed and used to make better corporate decisions. Each device contains at least two parts: a sensor for sensing the desired data and a communications module for transmitting the sensor’s output to the central repository. The modules usually transmit the information on cellular bands such as 2G, 3G, and 4G LTE over networks such as Verizon’s and AT&T’s. IoT customers are usually satisfied to use the older networks such as 2G and 3G because their data is low bandwidth and those networks are cheaper to use.
Telit is the leading provider of communication modules in the world and is on track to do about $375 million in revenue this year. Its revenue has grown at a 15-20% clip over the last five years and the growth outlook remains positive as the IoT market continues to expand. The company’s valuation is highly attractive at just 1x sales and 7x EBITDA, especially relative to its growth rate. Telit’s business model is appealing because its modules are designed into its customers’ devices which generally have long lifetimes as they are industrial products. This provides a fairly steady stream of revenue to Telit. In addition, as long as the company maintains a good relationship with its customers, it is likely to be designed into future product lines as well. Finally, the competitive landscape is fairly benign with only two other competitors (Gemalto (OTCPK:GTOFF) (OTCPK:GTOMY) and Sierra Wireless (NASDAQ:SWIR)) who do not generally compete on price but rather are satisfied to grow with the overall IoT market. It is difficult for new competitors to enter the market because of the difficulty scaling these types of businesses. Each communications module has about 160 parts, Telit offers 151 module types, and the company sells about 20 million modules per year; this complexity creates a significant barrier to entry.
So what do we believe the market is missing? Telit stumbled in the fall of 2015 due to weakness in its U.S. business. AT&T (NYSE:T) announced that it was shutting down its 2G network causing IoT customers using that network to scramble to find a new network to use. About twenty of Telit’s customers decided to wait for a new LTE network called LTE-Cat1, which was not yet available at that time. This pause in order activity caused a shortfall in Telit’s U.S. sales and led to a meaningful decline in the company’s stock price. LTE-Cat1 networks have become available this year, with Telit’s modules the first to be certified, and the company is predicting a significant recovery in its U.S. business as a result. The market, however is taking a wait-and-see approach resulting in the company’s discounted valuation. From our work, we are more confident about the prospects for the U.S. business and think that it will serve as a positive catalyst for the shares.
Given its revenue growth rate and potential for margin expansion, we feel that the stock should trade at a minimum of a 9x 2017 EBITDA multiple, resulting in a 3.85 GBP stock price or about 50% upside from current levels.
Disclosure: I am/we are long TTCNF.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
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