FKWL - Franklin Wireless: Small-Cap Tech Company Recovering With 5G Tailwinds

2023-03-17 12:40:12 ET

Summary

• Franklin Wireless is a 5G hotspot and software provider which has major carriers as customers, such as AT&T and T-Mobile.
• The company reported strong financial results for Q4,22 as its revenue increased by close to 400% and its losses declined as a portion of revenue.
• One of its customers, Verizon, previously recalled 2.5 million hotspots due to alleged "overheating" in 15 units. The financial impact of this is still unknown.

Franklin Wireless (FKWL) is a leading provider of wireless networking solutions such as 5G mobile hotspots, routers and even tracking technology. The company has had its stock price butchered by more than 80% since December 2020, which was mainly driven by a recall of its devices by one of its main customers, Verizon (VZ). However, a positive is the company has begun to recover its sales and saw nearly a 400% increase in revenue during the fourth quarter of 2022. The business also is poised to benefit from the growth in the 5G industry, which is forecast to grow at a rapid 56.7% CAGR and be worth close to $2.2 trillion by 2030. In this post, I'm going to revisit the Verizon recall, before discussing the latest drivers of these strong financial results, and revealing my valuation model and forecasts for the stock.

The Verizon Recall

In my previous post on Franklin Wireless in April 2022, I stated a "turnaround is possible but much risk looms." Its stock price already has started to "turnaround" at the time of writing with a 28% increase since my prior post or ~69% increase from its low in September 2022. The "risk" that looms is related to one of the company's prestigious customers Verizon, which ordered a huge recall of 2.5 million units, after "overheating and fire" hazards were alleged to have occurred in April 2021. At the time the "risk" was that the financial impact of the recall was unknown. As I run an investing group and many of my community invested in the stock, I personally contacted the company and asked if they could estimate the financial impact of the recall. Shortly after the company released a statement in its 2021 SEC filings and stated that the financial impact was "unknown" as litigation was still ongoing. Now although I agree legal processes do take a long time, we are still no closer to knowing the impact. But there are some positives.

Management released a further statement on the matter in its 10Q SEC filing for Q4 2022. The company stated that "we have been unable to recreate any device failures of the type identified by Verizon" and "all internal testing to date have confirmed the Jetpack devices are performing to normal parameters." I believe this makes sense as only 15 of the hotspot devices, was alleged to have overheated. Putting that into perspective that is just 0.0006% on 2.5 million devices. Therefore the likelihood that those 15 devices may have been an anomaly or had fans blocked by customers inadvertently is high in my mind.

In terms of litigation, the company states they have "not been served with any legal action" which is a positive sign. Given Verizon has a market capitalization of $153 billion and aims to have good relations with its suppliers, would it try to squeeze a small supplier with a hefty lawsuit? I think this is unlikely especially given the issue cannot be recreated. The company also states, "no liability has been recorded for this litigation" because "such liability is not probable." Now of course I am not saying the risk is over, especially given its CEO OC Kim is being sued by shareholders for allegedly making "short-swing profits". The claims suggest management sold shares, with insider knowledge of a recall before announcing to the public. Management denies these claims.

Business as Usual... 5G Tailwinds

A positive for Franklin Wireless is it looks to be "business as usual." In fact, the company reported strong financial results for the fourth quarter of 2022. The company reported $8.98 million in revenue, which increased by a blistering 398% from the $1.8 million reported in Q4,21. This fantastic result was driven by a number of solid products being launched in the 5G market.

The company announced a partnership with the Electronics and Telecommunications Research Institute (ETRI) of Korea to launch the country's "first-ever" 5G SD-WAN. To explain the details of this innovative technology I will break down each section. First the popular "5G" which is the fifth generation of cellular network is up to "100 times" faster than 4G, with download speeds up to 10G which is astonishing. Widespread adoption of this network could effectively unlock many new applications from live streaming 4K video to wireless augmented reality and virtual reality [VR] experiences (Metaverse). When this technology is combined with an SD-WAN or software-defined wide-area network, this basically enables the technology can be used to replace a wired network. This could be useful for employees which work hybrid or in work-from-home locations, often with poor web security. The 5G SD-WAN solution is currently in development and will be available in Korea in mid-2023. Given South Korea has been dubbed as the "most technologically advanced " country in the world and this is the "first" 5G SD-WAN in the country, this is a testament to the innovation of Franklin Wireless.

As an extra point, Franklin is the majority owner of "Franklin Technology Inc." an R&D facility located in Seoul, South Korea. Thus the company has "boots on the ground" and can easily bring the latest technology to the west.

Franklin's core business also has launched a new 5G hotspot with "Metro by T-Mobile," a telecommunications carrier. This device named the "JEXtream RG2100 5G, offers faster speeds than 4G and includes Franklin's mobile device management software. The hot spot includes the latest Wi-Fi 6 standard and makes it ideal for those working remotely or traveling.

Franklin Wireless also launched a similar hotspot with another major carrier AT&T (T), which is a positive sign. A new A50 5G hotspot also launched with Franklin Wireless on Feb, 10, 2023, and thus the company has plenty of 5G tailwinds ahead. Many people say can't a person just use their smartphone hotspot for Wifi, and their data connection. Yes, they can however often a smartphone hotspot is not as reliable and can often slow when multiple devices are attached. For example, the Franklin A50 can connect up to 20 devices, which makes it ideal for remote offices.

Margins and Balance Sheet

Franklin Wireless reported improving margins for the fourth quarter of 2022. Its operating margin improved from negative 97% or $1.77 million in Q4 21 to negative $1.366 million or negative 15% by Q4 22. This was a positive sign and was mainly driven by SG&A expenses growing at a slower rate than revenue, despite increasing year over year. R&D expenses also were down 11% year over year, which helped to reduce losses.

Its balance sheet contains $17.9 million in cash and cash equivalents. In addition to $16.6 million in short-term investments and ~$8 million in accounts receivable. The business also has around $7.4 million in inventory. In terms of "debt" I can't see any interest-bearing debt on its balance sheet but the company does have ~$315,000 in lease liabilities. Overall its balance sheet is solid.

Valuation and Forecasts

In order to value Franklin Wireless I have plugged its latest financial data into my discounted cash flow valuation model. I have forecast 10% revenue growth for "next year" which is fairly conservative given the prior growth rate was close to 400%. In years 2 to 5, I have forecast a faster growth rate of 17% per year. I expect this to be driven by the aforementioned tailwinds around 5G with new product launches from both AT&T and T-Mobile, as well as its South Korea-based SD-WAN.

To increase the accuracy of my model I have capitalized R&D expenses which has boosted net income. I have forecast a pre-tax operating margin of 15% over the next 10 years. This is fairly optimistic, but given the current operating leverage trends, I don't believe this is impossible.

Given these factors I get a fair value of ~$10 per share, the stock is trading at ~$5 per share at the time of writing and thus is ~51% undervalued.

The stock also trades at a forward price-to-sales ratio = 0.5, which is at a similar level to 2020.

Risks

Insider Trading/Verizon Recall/Litigation

As mentioned early in this post, the company's CEO is currently being accused of Insider trading. In addition, we have the unknown financial impact of the Verizon recall.

Small Cap

Franklin Wireless is a "small cap" with ~$58 million market capitalization at the time of writing. Thus expect a volatile share price with large swings of over 30% in a day not being uncommon.

Final Thoughts

Franklin Wireless is a truly innovative technology company and it's poised to benefit from the growth in the 5G industry. Its latest products with AT&T and T-Mobile are a testament to the fact that its products are still trusted in the industry. In addition, its 5G SD-WAN has huge potential in South Korea and then in the U.S. Given my valuation model and forecasts indicates the stock is substantially undervalued intrinsically, I will label the stock as a "buy." But beware, the Verizon recall cost (if any) is still unknown, and with it being a small cap, expect volatility.

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