Franklin Wireless (FKWL, Financial) had everything going for it. It was a small cap company founded in 1981 which finally got its big break with a major customer, Verizon (VZ, Financial). Franklin supplied Verizon with the popular 5G wireless hotspot, which was sold under the Verizon name as the Ellipsis Jetpack.
The stock price multiplied eight times over in 2020 and reached highs of $21 per share. However, then there were allegations that 15 of the devices had overheated in April 2021, and this prompted Verizon to recall an eye-watering 2.5 million units.
This was an extreme move by Verizon, but it was made to save any potential reputational damage. The share price of Franklin has fallen off a cliff as a result, down by 81% since April 2021 and even more compared to all-time highs at the end of 2020.
The failure was reportedly due to the potential of the lithium-ion battery to overheat. However, it should be noted that Franklin was “unable to recreate any device failures of the type identified by Verizon.” Some say the mass recall was an overreaction by Verizon. If that's the case, can the stock bounce back?
Business model
Franklin Wireless is a supplier of wireless products such as mobile hotspots and routers which support 5G technology. The company has the majority ownership position in Franklin Technology Inc., a research and development company located in Seoul, South Korea. Franklin Wireless then gets devices manufactured by two independent Asian factories, after which Franklin sells their products to wireless operators, distributors and partners such as Verizon, T-Mobile (TMUS, Financial), etc.
In the past, Franklin Wireless had partnerships with other major players such as Qualcomm (QCOM, Financial) for a smart tracking solution. In addition, the company recently scored a partnership with C Spire to sell the “Jextream” 5G wireless hotspot. Franklin also recently announced it had surpassed 50,000 subscribers for its Mobile Device Management Service (MDM) , a remote access service for schools and businesses.
This is all great news for Franklin Wireless, given the dark thunder cloud that is the Verizon recall.
Verizon Recall
Franklin supplied Verizon with the popular 5G wireless hotspot which was sold under the Verizon name as the Ellipsis Jetpack. Then, on April 8, 2021, Verizon recalled a staggering 2.5 million units due to the potential of the litium-ion battery to overheat.
This was an extreme move by Verizon given only 15 devices were alleged to have overheated, just 0.0006% of 2.5 million devices. The strange thing is, only two of the devices involved in the 15 incidents had been inspected by Verizon, and Franklin was “unable to recreate any device failures of the type identified by Verizon."
However, this didn’t stop the stock market from selling the stock intensely, causing investors to file a class action lawsuit against Franklin for allegedly "misleading" them. As the stock is a small cap, high risk and volatility are to be expected, but when people think they can get money, they will try; thus, the lawsuit.
What will be the cost of the recall?
The key question on investors' minds and the only truly rational way of valuing the company today is by estimating, “What will be the cost of the recall?” According to Franklin Wireless as per their latest earnings report one year after the recall, “We are not currently able to estimate the financial impact of the recall on our future operations.”
The good news is the company has a strong balance sheet with $36 million in cash and cash equivalents and virtually no interest bearing debt with just $5 million in accounts payable and lease liabilities.
As an approximate estimate, the Franklin Wireless T10 Hotspot 4G costs $90, and the Ellipsis Jetpack which was recalled should cost similar, though we don't know for sure what price Verizon managed to negotiate for the devices due to buying in bulk. With a ballpark estimate of $50 per unit, a 2.5 million unit recall could be worth a whopping $125 million.
However, Franklin doesn’t manufacture these devices but outsources the manufacturing. Thus, they may be able to pass some costs on. In addition, this was a voluntary recall by Verizon, and Franklin claims it hasn’t been able to recreate the issue, so there may be grounds for Franklin to launch litigation of its own.
In the best case scenario, this cost could fall to Verizon, which has a market capitalization of $226 billion. Writing off this cost rather than battling with a lack of evidence could be the cheaper option for Verizon, as the cost of the recall is truly a drop in the ocean for them. They care more about reputation.
Financials
Franklin’s short term financials aren’t great. Net sales decreased by 96%, or $123.6 million, to just $5 million for the six months ended in December 2021. They stated this was driven by a “reduction of demand” from two major carrier customers. However, the company does caveat this by saying they had “unprecedented high demand in the prior period."
This is technically correct but doesn’t show the full story, which could be that networks such as Verizon don’t wish to buy any more products from them. The company seems fairly relaxed about this with minimal statements. Either they view this as part of the business cycle or are just holding their cards close to their chest.
An overview of the company’s website shows they have revamped their website, releasing new products and even hiring people, so I suspect things may be as bad as they seem. Up until this most recent quarter, the company’s financials and net income had grown substantially.
Valuation
In terms of valuation, the company is trading at a $45 million market cap, which is just 1.2 times the $36 million cash on the balance sheet. The GF Value chart, a unique intrinsic value estimate from GuruFocus, rates the stock as modestly undervalued.
On paper, Franklin Wireless has a lot going for them. They are an established player in the growing wireless internet market and have partnerships with major carriers and great technology.
However, the Verison recall has caused a large amount of uncertainty to hang over the company as no estimates of the costs have been released. In addition, the company's president sold 50% of his shares prior to the large decline, which has led to many lawsuits which claim insider trading occurred as insiders were aware of the recall before this was reported publicly. A director and 10% owner, Jyoung Joon Won, also sold a third of his position, as did the chief operating officer. These are red flags add even more to the lawsuits moving forward.
Thus, while a turnaround is possible, much uncertainty looms. Getting involved with this stock would be an incredibly risky shot in the dark, with extra baggage attached.
