GMP tackles currency impact on wireless sector; drops most target prices

Hooray for GMP’s wireless research team for dealing with the recent strong move in the CDN$. While we saw plenty of adjustments to analyst eps forecasts in the late summer (see prior post “Calling all software equity research analysts part 2“, June 5-07, “Scotia Capital shaves Cognos on CDN$ move” June 6-07), September was quiet on this front despite a big move against the US$.

The impact is clear: GMP is dropping numbers and ratings across the board on most of their names. 2008 revenue forecasts were dropped for Ascalade, COM DEV, Call Genie, Hemispehere GPS, Intrinsyc Software, Air IQ, Sirit, Sierra Wireless, WebTech Wireless, and Wireless Matrix. 2008 EPS forecasts were also dropped for all of these names except for Sirit.

Price targets were dropped for Ascalade, COM DEV, Call Genie, Hemispehere GPS, Intrinsyc Software, Air IQ, Sierra Wireless and WebTech Wireless. Only RIM and Wireless Matrix survived unscathed here.

Call Genie was raised to a buy, Hemisphere GPS was dropped to a Hold, Air IQ was raised to a buy, RIM was dropped to a Hold, and WebTech Wireless was lowered to a reduce.

“Year-to-date the Canadian dollar has risen roughly 17% versus the US dollar including a 5%+ surge over the past month. In this brief report we will provide a snapshot analysis and the overall impact of the US$/C$ across our coverage universe. Companies within our coverage sector generally have operating expenses weighted towards C$ costs with US$ revenue representing over 60% of sales on average.

Our revised currency assumptions are based on GMP’s Q3 rolling forward US$/C$ exchange rate to US$1.01 versus our Q2 currency rate of US$0.93. Please note that the Canadian dollar was US$0.94 at the beginning of the quarter, par at the end, and averaged US$0.96 during the period. Therefore, the rise is the Canadian dollar will affect reported results but that valuations and recommendations are based on GMP’s new Q3 currency modelling assumption.

RESEARCH IN MOTION – MARKET CAP NEARS US$60 BILLION AS STRONG QUARTER AND GUIDANCE DISCOUNTED

RIM has appreciated over 81% since the release of the Q1/F08 financial results. We currently feel comfortable with our above-consensus estimates for Q2 and Q3 of F08. Beyond F08, RIM’s exposure to Canadian dollar operating expenses is the reason behind our slight increase in our expense assumptions. We now forecast R&D growth of 30% in F09 (which compares to 35% growth in F08E and 49% in F07A).

The more material change in our RIM model is our expectations on unit sales. We now forecast
19.0 million units in F09 versus 17.7 million previously. This results in a US$400 million boost to F09 sales and an overall increase in EPS to US$2.70 from US$2.46, inclusive of the increased Canadian dollar costs. We are introducing F10 revenue and EPS of US$9.1 billion and US$3.16.

Other highlights for F10 include 33 million BlackBerry subscribers, 26 million units shipped (with a 10% decline in prices versus F09) representing less than 2% market share of Worldwide handset sales.

RIM’s exceptional profitability combined with World-leading branding merits a premium market multiple.

However, at current levels this still results in a 33x multiple to our F10 EPS estimates. While our
Q3/F08 and Q4/F08 estimates suggests a strong upside quarter and bullish guidance we are lowering our rating to HOLD from BUY. Our new target price of US$95.00 is based on 30x our
F10 EPS of US$3.16. We will be publishing an intra-day RIM comment.

SIERRA WIRELESS – LOWERING ESTIMATES AND TARGET ON REDUCED ASP ASSUMPTIONS

At the end of Q2/F07 Sierra Wireless reported 76% of revenue from the Americas, 11% from EMEA, and 13% from Asia-Pac. Sierra is exposed to various global currencies as the company operates and distributes its products in several different countries. Currently the company does not have any form of sophisticated currency hedging programs. The company’s operational expenditures such as research and development, sales and marketing and administration costs are accounted for in C$. Sierra reduces its US dollar exposure by purchasing inventory, cost of goods sold and services in US$.

We are comfortable with our below-consensus 2H/F07 revenue forecast. We are trimming our F08 outlook as Sierra’s modest exposure to recent currency trends will likely negatively impact near term results. Principally we have trimmed our ASP assumptions by 5% on AirCard and OEM revenue. We are leaving AirLink and MP unchanged at this time as we believe the company can manage the customer base for these respective products (orders tend to be batch oriented).

Our F08 revenue and EPS drops as a result to US$476.1 million and US$1.12 versus US$494.7 million and US$1.35 previously. Our sales and marketing operating expense forecasts are already conservative although our R&D assumption of US$50.4 million is likely light given the large C$ orientation for this line item. We have bumped our F08 R&D to US$53.6 million which has a US$0.07 negative impact to our EPS change. We apply an unchanged 25x multiple on our lower F08 EPS to arrive at our new target price of US$28.00 (from US$33.75). We maintain our BUY rating and re-iterate our thesis that Sierra is well positioned to benefit from our sector thesis on the convergence of Internet computing with the wireless networks.

COM DEV – LOWERING TARGET DESPITE RECORD BACKLOG AND EXPANSION EFFORTS

COM DEV recently reported Q3/F07 financials of C$42.9 million and C$0.04. Although revenue and profitability were lower than our estimates and consensus, the company reported record revenue, strong bookings of C$50 million and record backlog of C$135 million. The quarter was materially impacted by the strengthening of the C$ from a revenue, gross margin and profitability perspective.

Management has implemented forward currency hedging programs in the low $0.90s with F08
assumptions of a par dollar.

While we are bullish on the outlook for COM DEV’s US expansion (and its efforts to gain US military business over time) the implication of this expectation in the context of this note is lowered revenue when translated to the reporting currency. We are lowering our F08 revenue by 4% from C$216.2 million and C$0.35 to C$207.0 million and C$0.31. In addition we are increasing our F08 R&D expense from C$10.8 million to C$11.6 million. The company has not provided specific F09 financial guidance, however, management indicated during the last quarterly conference call that the outlook for the satellite industry remains solid. We are introducing F09 estimates of C$248.4 million and C$0.38. We apply a 20x P/E multiple to our new F08 EPS estimates of C$0.31 to arrive at our new C$6.20 target price (from C$7.00). Maintain BUY rating and thesis that COM DEV is well positioned to drive above-industry growth rates fuelled by significant expansion efforts in the Cambridge, Ontario and new US facilities.

WEBTECH WIRELESS – REDUCE RATING; SIGNIFICANT REDUCTION IN F08 AND F09 ESTIMATES

In the first nine months of F07 WebTech received 80% of its revenue in US$ and 9% in U.K. pounds. Currently the company does not have a currency hedging program in place. In mid-June the company reported disappointing financial results of C$9.6 million and a loss of C$0.38 per share. The Q3 results were highlighted by several one-time items including a full write-down of a loan receivable from Brazil distribution partner Crown Telecom of C$13.3 million, a bad debt expense of C$1.6 million and an inventory write-down of C$4.1 million. This was the result of Crown’s breach of loan interest payments as well as receivables owed. At the time we lowered our Brazil shipment assumptions from 372k to 252k units in F08. Recently CONTRAN (the National Transit Road Transportation Council), the Brazilian government body governing the Brazilian highway and transit system mandated that all vehicles will require some form of telematics within 2 years. The new development is generally bullish for the company, however, the demand-based model will not include volume commitments like its previous contract.

Subsequent to the introduction of legislation, Brazil-based consumer interests groups have raised significant opposition to the forced mandate of vehicle location based on civil liberty concerns.

Its widely speculated that WebTech will soon win formal business from FedEx (a logical extension to the paid pilot project from a year ago). We believe that this development is already anticipated by the market as the stock has moved 50%+ to the upside over the past month. In addition, our estimates already reflect aggressive growth estimates and anticipate a FedEx-like deal (our hardware revenue outside of Brazil are projected to increase from C$10.4 million in F07 to C$23.0 million in F08 to C$36.6 million in F09). Our call is that the company will talk down street estimates for Brazil at the same time that a deal will be struck with a signature commercial account and/or an improved (but much smaller) Brazil distribution deal.

Current consensus EPS estimates are C$0.17 for F08 and C$0.30 for F09. We are significantly reducing our revenue contribution from Brazil for F08 to C$7.5 million from C$29.0 million. This assumes 50,000 units get sold through at US$150. In F09 our estimates from Brazil have decreased from C$56.6 million to C$9.4 million. We have lowered our F08 financial estimates from C$60.6 million and C$0.20 to C$39.7 million and C$0.11. In addition we are modifying our F09 estimates from C$105.2 million and C$0.33 to C$60.1 million and C$0.16. We are shifting our valuation metrics out to F09 July. Our new target price of C$2.40 (from C$3.00) is based on applying 15x P/E to our lowered F09 EPS estimate. We are lowering our recommendation from HOLD to REDUCE.

We would take a more bullish position on the company once we receive better clarity on the
status of major customer engagements such as FedEx or in Brazil.

CALL GENIE – UPGRADING TO BUY RATING DESPITE LOWER TARGET PRICE

We are reducing our revenue expectations due to Call Genie’s exposure of U.S. domiciled revenue from key customers such as Jingle and Verizon. Specifically we have lowered our automation revenue per call from the DA business and YPG revenue expectations. We are also taking this opportunity to revise our operational expenditure assumptions higher for F08 from C$18.7 million to C$19.3 million and C$23.1 million to C$24.2 million in F09. The net impact to F09 EPS is a drop from C$0.09 to C$0.08. We are lowering our valuation multiple from 25x to 20x to reflect the long tail of our current revenue expectations. Our new target of C$1.60 is based on 20x P/E our slightly lowered F09 EPS of C$0.08 (previously our target price of C$2.25 was based on 25x our F09 EPS estimates). We are upgrading our rating from HOLD to BUY. We caution investors on the customer concentration risk of key customer Yellow Pages Group over the near term.

HEMISPHERE GPS – LOWERING FINANCIAL FORECASTS, RATING AND TARGET PRICE

Hemisphere GPS has undergone a dramatic transformation over the past several years. The company acquired its precision agriculture distributor, acquired Del Norte Aerial GPS business, divested its Telematics and Fixed Wireless divisions, changed senior management, and ultimately fell far short of product and financial objectives. After significant volatility the outlook for the business has improved due to improving customer fundamentals. The growth of the precision agricultural market is driven by high commodity prices, record level of income generated by farmers, as well as increased levels of investment in the farming community.

Our previous Hemisphere estimates somewhat reflected the company’s high risk of currency exposure.

We are decreasing our F07 and F08 revenue estimates further from C$54.4 million and C$65.0 million to C$51.4 million and C$63.0 million. Our operating expenses are largely untouched although the company does have a medium-sized facility in Arizona and a satellite office in Kansas City. The company has recently resolved its litigation issues relating to patent infringement with Trimble Navigation, previously a drag on financials. Although our operating expenses are largely unchanged our F08 EPS drops to C$0.12 from C$0.15 previously. Its noteworthy that as of Q2/F07 the cash position was C$12.4 million and we project operating cash flow of operations of negative C$4.0 million for the balance of this year. The company appears amply liquid to fund its operations until the seasonally stronger first half of the fiscal year. We apply a 20x multiple to our new F08 earnings to arrive at a new price objective of C$2.40 (previously C$3.00). We are lowering our rating from BUY to HOLD. We would take a more bullish position on the investment thesis once it becomes evident that the company is monetizing on the improving financial fundamentals of the agriculture sector.

WIRELESS MATRIX – AMORTIZATION COSTS LOWERS PROFITABILITY IN F09; MAINTAIN C$1.30 AND BUY

Wireless Matrix is well hedged with headquarters in Reston, Virginia, US$ reporting with US$ revenue, incurs significant US$ operating expenses, and trades on the TSX in C$. In mid-September the company reported solid revenue of US$7.85 million and net loss of US$0.4 million or a loss of US$0.005 per share. Wireless Matrix ended the quarter with 52,946 total subscribers and recently announced that the company had surpassed 54,000 subscribers. The sales pipeline remains solid with over 35 small pilots and deployments as well as potential new business from its recent acquisition of Sapias.

We have lowered our F08 financial estimates from US$33.9 million and US$0.00 to US$33.0 million and (US$0.01). In addition we are modifying our F09 estimates from US$40.8 million and US$0.04 to US$38.7 million and US$0.01. Our lowered F09 EPS estimates reflect an increase amortization of goodwill costs from its acquisition of Sapias. The company trades at 2.0x our April, 2009 P/S forecast.

We are changing our valuation methodology at this time from a P/E multiple to P/S model. We believe that Wireless Matrix merits a premium valuation to its peer group (trading at 1.7x December, 2008 P/S) as the company features an attractive recurring revenue model. Our unchanged target price of C$1.30 is based on our new 3.0x P/S F09 revenue estimates of US$38.7 million. Maintain BUY rating but highlight that profitability for the company remains elusive.

INTRINSYC SOFTWARE – MODESTLY DECREASING TARGET PRICE TO C$0.95

In Q3/F07 Intrinsyc reported C$2.9 million or 56% of total revenue from the U.S., 7% from Canada and the remainder from Europe and other. Intrinsyc is headquartered in Vancouver, Canada and has development and business offices in Bellevue, USA; Cupertino, USA; Birmingham, UK; Taipei, Taiwan; and Barbados. Intrinsyc’s exposure to the currency movement is concerning as the company incurs over half of its revenue base from professional services and licence revenue in US$ and accounts a significant portion of its operating expenditures in C$.

Our F08 estimates have been lowered from C$24.8 million and (C$0.13) to C$23.7 million and
(C$0.14). In addition we have lowered our F09 estimates from C$35.9 million and (C$0.09) to C$33.4 million and (C$0.11). We are reducing our license ASP assumptions by roughly 5% on average which has the most meaningful impact to our Q3 and Q4 estimates in F08 as well as F09. As a part of our adjustment we have also increased our F08 and F09 operational expenditure assumptions (in administration expenses) by C$0.2 million. We apply a 3.5x P/S multiple to our new F09 revenue estimate of C$33.4 million to arrive at our lowered price objective of C$0.95 and maintain our BUY rating. The key driver to our investment thesis on Intrinsyc is based on a unusually strong management team attacking a significant market opportunity with a product that is now commercially viable.

SIRIT – PROFITABILITY NEARS

Sirit has significant US$/C$ exposure as the company collects the majority of its revenue in US$, maintains its cash balances in US$, reports its financial results in C$, and lacks a currency hedging program. In the company’s Q2/F07 results the US$ depreciated approximately 9% against the C$ and resulted in a foreign exchange loss of C$0.9 million (significant when considering the C$7 million in revenue for the quarter).

We have lowered our F08 financial estimates from C$32.9 million and (C$0.02) to C$32.5 million and no change in EPS. Our AVI revenues remain unchanged, however, we are trimming back our
expectations for RF Solutions growth. We are lowering our RF Solutions anticipated growth rates to 20% and 40% in F08 and F09 versus previous expectations of 25% and 50%. We remain confident that commercial RFID bid activity is robust and Sirit will capture some of the growth (at least one C$2 million per year customer in F08 and two C$2 million customers in F09 plus existing business to hit our estimates).In addition we are modifying our F09 estimates from C$39.9 million and C$0.01 to C$38.4 million and no change in EPS. We apply a 3.0x P/S multiple to our slightly modified F08 sales to arrive at our unchanged price target of C$0.65. We maintain our BUY rating as we believe that Sirit is nearing a phase of profitable growth at the same time industry maturity is opening up significant bid activity.

ASCALADE – DEEP VALUE DESPITE RECENT EARNINGS MISS

Ascalade’s principal operations are located in Richmond, British Columbia, Canada and in Dongguan, China (expected to relocate to Qingyuan within the Guangdong Province by Q4/F07). The majority of Ascalade’s revenue are booked in US$ and for financial reporting purposes the company reports in US$. We are adjusting our operational expenditure higher to reflect the company’s exposure to Canadian administrative, R&D, and headquarter-related operating expenses.

We are lowering our revenue expectations to reflect our views on the company’s product prospects in cordless phone and VoIP. Our F08 VoIP revenue forecasts are now US$30.2 million in F08 versus US$35.3 million previously. The biggest change to our forecast model is that we assume that Ascalade will defocus its cordless phone business. We now estimate a year-over-year decline in F08 sales to US$53.0 million versus US$75 million previously. In contrast, we are boosting our forecasts for multimedia revenue and expect this new product category to grow quickly to US$30.0 million in F08 versus US$7.5 million in F07. Overall sales in F08 drop to US$131.3 million from US$150.9 million previously. The company has secured 5 forward currency contracts based on the Chinese Yuan for the build out of it new manufacturing facility in China. The implications are material to our EPS estimates. Our F07 EPS drops from (US$0.18) to (US$0.28) and F08 drops from US$0.17 to US$0.04. We believe these estimates are conservative and that there is upside potential on F08 EPS which we will adjust as new leadership in management executes on a turn-around strategy. After delivering four consecutive quarters of solid results the company continues to deal with the blow suffered from significant organization changes at lead customer Philips.

In our last note, “Disappointing Q2 results”, we estimated that the company had a projected end of F07 minimum tangible book value of C$2.15 per share, a significant discount to the current share price. In our view the market value of assets on the balance sheet understates the true value of assets such as physical land and facilities. We believe that the conservative book value of the company includes attractive assets such as the land and factory in China worth US$20 million, Vancouver offices C$5 million, cash of US$8 million (versus US$17 mm today) net of burn and first phase factory building costs. We place zero value on items such as the US$14.8 million inventory but do add a further US$7 million value on other assets resulting in our updated end of F07 conservative book value of C$2 per share.

We are now moving to a Price/EBITDA valuation methodology approach as the drop in our projected F08 EPS renders P/E metrics not meaningful. We apply a 6x F08 EBITDA multiple (previous target price of C$2.70 was based on a 15x P/E multiple to our F08 EPS forecast) to arrive at our new price objective of C$2.50. We believe this valuation approach is consistent with potential private equity buyers. Maintain BUY rating.

AIRIQ – UPGRADING TO BUY

Approximately 60% of AirIQ’s revenue is booked in US$. At the same time the company’s cost of goods (for items such as hardware and wireless airtime) has also become cheaper as the US currency weakens. We believe the correct adjustment to make to the forward earnings model is a reduction in ARPU assumptions from US-based customers. Therefore, we are reducing ARPU assumptions for the (profitable) Boatracs division as well as the commercial subscriber business for the company.

Previously we had forecasted modest top-line growth for AirIQ with C$29.4 million in F08 sales versus C$28.9 million in F07. We are now forecasting a decline on F08 revenue to C$27.2 million versus our revised F07 revenue of C$28.1 million. We are leaving our operational expenditures unchanged as we are comfortable that they are sufficiently conservative to reflect the rise of the C$. Our net income estimates for F08 drops to a loss of C$4.3 million versus C$3.4 million previously. Note that the end of the last quarter the company had approximately C$0.05 in cash per share. Separately if we apply the take-out valuation metrics of 1.5x P/S from the divestiture of its Vehicle Finance division and apply it to our new F08 revenue estimates of C$27.2 million we would arrive at a share price of C$0.25. Our new target price of C$0.13 (from C$0.18) is based on a lowered 0.75x multiple to our new F08 revenue estimate of C$27.2 million. We are upgrading our rating from HOLD to BUY.”

MRM
(disclosure – Wellington Financial Fund II owns warrants in Air IQ and Intrinsyc Software; I own RIM personally)