ALRM - Lantronix: Positioned For Success In Industrial IoT Market With Specialized Products And Strategic Acquisitions

2023-04-12 14:59:44 ET

Summary

• The growing demand for industrial IoT applications, such as smart cities, smart grids, remote healthcare, industrial modernization, and defense security, presents a significant opportunity for Lantronix.
• The company remains confident in the transformative impact of the Gridspertise win and expects to achieve ~15% EBITDA margin in FY24, driven by revenue growth and operating leverage.
• It has been expanding its IoT product portfolio through strategic acquisitions and is well-positioned in the industrial IoT market with specialized products and relatively few direct competitors.
• I keep the end-of-fiscal year 2024 price target of $10.45 on the stock, derived from an EV/sales multiple of 2x applied to the FY24 revenue estimate.

Editor's note: Seeking Alpha is proud to welcome Arbab Shahzeb as a new contributor. It's easy to become a Seeking Alpha contributor and earn money for your best investment ideas. Active contributors also get free access to SA Premium. Click here to find out more »

Investment Case

Lantronix, Inc. (LTRX) is looking to strengthen its position as a supplier of wired and wireless IoT devices for various industrial segments. In my view, the growing demand for industrial IoT applications, such as smart cities, smart grids, remote healthcare, industrial modernization, and defense security, presents a significant opportunity for LTRX. The company remains confident in the transformative impact of the Gridspertise win and expects to achieve ~10% EBITDA margin in FY23 , driven by revenue growth and operating leverage. LTRX has been expanding its IoT product portfolio through strategic acquisitions and is well-positioned in the industrial IoT market with specialized products and relatively few direct competitors. I keep an end-of-fiscal year 2024 price target of $10.45 on the stock derived from an EV/sales multiple of 2x applied to the FY24 revenue estimate.

Post F2Q23 Outlook

Lantronix reported in-line F2Q23 results but provided a conservative FY23 guidance due to a delay with its new Gridspertise contract. Despite this setback, LTRX remains confident in the transformative impact of the Gridspertise win and expects to achieve ~10% EBITDA margin in FY23, driven by revenue growth and operating leverage. Management reported early shipments to new EV customer Tog and an aggressive shipment schedule for its $40 million Gridspertise contract.

Despite modest macroeconomic headwinds, the overall demand for Lantronix remained strong in 2022. The company's focus on turn-key solutions and specialized products has made it a leader in the industrial IoT market, and its strong position in this market sets it up for further success in the future. While supply chain issues showed signs of improvement, LTRX still faces difficulty accessing certain components, although it is not significantly impacting revenue. Large contract wins remain a key growth driver for the company in my view, with the major smart-grid win with ENEL and the major EV win with Tog both positioning the company well for growth.

Core Products and Target Markets

Lantronix is a company that specializes in providing IoT and Remote Environment Management solutions primarily for industrial applications. These solutions include engineering services, software-as-a-service (SaaS), connectivity services, and hardware. The company offers a range of products, such as embedded modules, gateways, and remote management platforms that can be connected through wired or wireless connections. Lantronix also offers customization services for software and API integration with chip partners such as Qualcomm. The company's key applications include industrial, utilities, data center, warehousing, fleet management, and enterprise.

IoT connectivity products provide network connectivity for machines, allowing users to access and control them remotely. IoT computing enables advanced application functionality at the edge for data transformation, AR/VR, machine learning, and audio/video aggregation and distribution. IoT telematics provides smart tracking devices for supply chain and logistics solutions. Engineering services are available for the development of innovative products. SaaS platforms enable customers to deploy, monitor, manage, and analyze global deployments of IoT devices.

The IoT Market

IoT, or the Internet of Things, is a term used to describe the growing number of devices and machines that are being connected to the internet, allowing for increased automation and potentially new business models. This trend has been enabled by advancements in wireless networks and the miniaturization of hardware used to connect devices to the internet. As a result, the number of IoT devices deployed has grown rapidly, with IoT Analytics forecasting the IoT market to grow at a CAGR of 19.4% to $483 billion from 2022 to 2027. To fully leverage the benefits of IoT devices, software is essential to enable control, monitoring, updates, and other functions. The robust growth outlook highlights the strong potential for both hardware and software associated with IoT deployments.

I believe the use of IoT devices has the potential to increase efficiency and reduce costs in various industries while also creating new business opportunities. However, there are concerns about privacy and security when connecting devices to the internet. As such, there is an increasing demand for IoT solutions that prioritize security and data privacy. In summary, IoT is a significant technological trend with the potential to revolutionize various industries. As the market for IoT devices and software continues to grow, companies that can provide secure and effective solutions are likely to experience strong demand for their products and services.

Recent Acquisitions

Lantronix has been expanding its IoT product portfolio through strategic acquisitions . In 2019, the company acquired Intrinsyc to enhance its IoT computing and embedded product development capabilities. It also acquired Maestro to expand its wireless IoT offerings and include asset tracking software and cellular connectivity. In 2021, Lantronix entered into an agreement to acquire Communication Systems' Electronics and Software business segment, which includes Net2Edge and Transition Networks product lines. This acquisition is expected to strengthen Lantronix's position in smart cities, intelligent transportation, and security markets and provide more comprehensive solutions to its customers. These strategic acquisitions demonstrate Lantronix's commitment to expanding its IoT product offerings and strengthening its position in the rapidly growing IoT market.

TAM & Competition

There are several factors driving the growth of Lantronix in the industrial IoT market. One of these factors is the rigidity of legacy software platforms, which has hindered the growth of this market over the past decade. However, the emergence of open API architectures has allowed for a more modular approach to assembling solutions, leading to increased adoption of industrial IoT applications. This trend can be seen in various industries, such as data centers, energy production, and municipal infrastructure.

In my view, LTRX is well-positioned in the industrial IoT market, with specialized products and relatively few direct competitors. Its high gross margin of ?50% is a testament to its strength in this market. While the company competes with several other players, such as Digi International/OpenGear, Red Lion, Sierra Wireless, Cradlepoint/Ericsson, Peplink, NetGear, and Thundercomm, it has differentiated itself by providing turn-key solutions to customers.

To gain scale and provide comprehensive solutions to its customers, LTRX has made several strategic acquisitions in recent years, which have slightly impacted its gross margin. However, this strategy has positioned the company well for growth in the industrial IoT market, especially in modernizing legacy industries such as smart cities and military/defense. LTRX's focus on turn-key solutions and specialized products has made it a leader in the industrial IoT market and sets it up for further success in the future.

Valuation

To value LTRX, I compare it to what I view as its nearest public comparable companies, most of which it competes within the IoT space. These companies are generally larger than LTRX, but otherwise have similar (if slightly higher) growth profiles on average and similar (average) profitability profiles. The comp group I have selected includes companies like Alarm.com Holdings, Inc. ( ALRM ), Clearfield, Inc. ( CLFD ), Digi International ( DGII ), and Inseego Corp. ( INSG ). Given that some of these companies have meaningful recurring service/software businesses, which in theory should afford them a premium multiple, it is justifiable in my view that LTRX trades at a modest discount to the group.

Since LTRX is not yet profitable on an operating level, I chose to value the company using the EV/sales methodology. Lantronix shares trade at a lower EV/Sales multiple compared to the average for IoT companies, despite having above-average gross margins. This presents a compelling opportunity for LTRX, particularly in the industrial IoT market, which has underperformed expectations in recent years. History suggests that the management can leverage its extensive M&A experience to acquire underperforming assets in a fragmented market, which could drive revenue synergies and earnings growth, as well as enable future M&A activity.

As LTRX continues to execute on its growth strategy and achieves greater scale, the shares will trade more in line with the peer group average, in my view. Hence, I keep an end-of-fiscal year 2024 price target of $10.45 on the stock derived from an EV/sales multiple of 2x applied to the FY24 revenue estimate .

Risks

Lantronix outsources its manufacturing to contract manufacturers based in China, Taiwan, and Thailand, which presents an ongoing challenge for the company's supply chain. With the increasing geopolitical tensions between US and China, the company is exposed to geopolitical risks and would suffer if there is an increase in tensions and further impositions of trade tariffs. Moreover, the recent surge in COVID-19 infections in China, also impacts the company's supply availability and can materially affect the company's financial results in the near term. Moreover, Lantronix may experience lumpiness in its financial results due to the nature of its IT Management products, which are typically sold in larger transactions that are recognized over a limited number of quarters. If one or more of these transactions slip across a quarterly boundary, it could materially impact the company's quarterly results, potentially leading to volatility in the stock. Additionally, while Lantronix does not have significant revenue concentration at the end-customer level, it does have meaningful concentration among its distribution partners. This concentration may also lead to volatility in Lantronix's financial results if there are any changes in these partnerships or their performance.

Final Thoughts

Lantronix is a turn-around story in the industrial IoT market, aiming to acquire underperforming assets and maximize their performance. The company aims to build on its position as a provider of wired and wireless IoT devices for multiple industrial segments. LTRX is focused on integrating accretive acquisitions to drive performance. The trend towards increased investment in industrial IoT applications, including smart cities, smart grids, remote healthcare, industrial modernization, and defense security, is a structural positive for LTRX. With a focus on maximizing performance from underperforming acquired assets and scaling up, I believe LTRX is positioned for growth in the industrial IoT market. I keep an end-of-fiscal year 2024 price target of $10.45 on the stock derived from an EV/sales multiple of 2x applied to the FY24 revenue estimate.

For further details see: