Goldman Sachs recently published a report called “The Internet of Things: Making sense of the next mega-trend.” According to Goldman Sachs, the Internet of Things (IoT) is emerging as the third wave in the development of the internet and has the potential to connect ten times as many “things” to the internet by 2020, ranging from bracelets to cars. The recent news release of Cadillac planning on offering a hands-free driving car by 2016 and Goldman Sachs’ report reminded me of the small-cap semiconductor company I found last month using GuruFocus’ All-In-One screener to find small-cap stocks with large growth potential. The stock I am referring to is u-blox Holding AG (XSWX:UBXN, UBLXF).
17 stocks were mentioned by Goldman Sachs as a way to participate in the IoT, but u-blox has slipped under the radar and not been mentioned at all. It could be because the company is a small cap headquartered in Switzerland with no coverage here in the United States. It last traded in the U.S. on the pink sheets back in March, and the total volume for the day was 350 shares. Its average volume on the SIX Swiss Exchange is 23,485 for the past three months.
Company background
U-blox was initially a spin-off from the Swiss Federal Institute of Technology in 1997 and made its IPO on the Swiss exchange in 2007. The company describes itself as a fabless semiconductor provider of embedded positioning and wireless communication solutions. The fabless model means that u-blox engineers and designs the product while the manufacturing component of the business is outsourced to other companies such as GLOBALFOUNDRIES, Taiwan Semiconductor (TSM), Amkor (AMKR) and Flextronics (FLEX). The outsourcing of manufacturing allows more time and money for research and development and customer service. A majority (69%) of u-blox’s employees are working in research and development.
According to Goldman Sachs, there are five key early verticals of adoption: wearables, cars, homes, cities and industrials. U-blox has made direct comments about the IoT in its latest annual report:
“Our products serve virtually all growth sectors that make up the 'Internet of Things' (IoT). U-blox is positioned at the heart of this megatrend, able to deliver crucial chips and modules for both embedded positioning and wireless communications. With the IoT theme now firmly established, demand for our products has proliferated right across our core markets.”
Most of its customers are in the industrial segment. The annual report gives the example of improving inventory functions by portraying its part in the process of tracking shipments of bananas from the local farm to the checkout at the grocery store across seas. Its chips also allow communication between machines in the manufacturing industry. For high levels of efficiency, it is critical that machines understand its own positioning and be able to communicate in a flexible, just-in-time process. In my experience in the automotive industry, the biggest challenge while designing a plant was how to automate the process of getting the right parts to right cell at the right time. U-blox’s technology helps enable the communication between machines and understanding of positioning in order to do so. Its full line of applications to the industrial sector include: fleet management, asset tracking, network infrastructure, professional radios, smart utility reading, payment, security and healthcare.
Coming in second for its customers is the automotive industry, meaning the parts in the cars themselves. Although the self-driving Cadillac story reminded me of u-blox, there is no mention of its parts being used in the cars. It is known that u-blox has components in cars manufactured by BMW, Mercedes and Audi. The company’s parts are applied to the areas of infotainment, vehicle-to-vehicle communications, security and insurance. Vehicle-to-vehicle communication is going to be a large part of self-driving cars. U-blox also recently announced its 3D Automotive Dead Reckoning product in February. It allows cars to understand its position when GPS signals are unavailable, such as stacked highways and parking garages. It has a product range that allows communications in the short range, cellular and long range levels.
Financial strength
One of the aspects that brought u-blox to my attention is its strong financial strength where the company scores an 8/10. The latest report ending June 30, 2014, shows CHF 30.39 million in cash on the balance and a short-term bank loan of CHF 20 million at a variable interest rate of 0.6 percent. The loan was used in the purchase of connectBlue AB, which is now called u-blox Malmö AB. The company typically carries no long-term debt and uses free cash flow for acquisitions. The different measures of inventory management have been positive as well. Revenue has been increasing at a faster rate than inventory. The annual increase in revenue was 29.94 percent compared with 27.2 percent for inventory. Days inventory have been decreasing at an annual rate of 5.73 percent meaning that their inventory is being handled in an efficient manner, and the product is not sitting around too long. It makes sense that its inventory is becoming more efficient since that is what its product is designed to do for the industrial sector.
U-blox scores an 8/10 for Profitability & Growth. It has a return on equity of 13.66 percent combined with a high return on capital (ROC) of 44.87 percent. The fabless model leads to much smaller capex spending compared to companies that run their own manufacturing plants. As far as earnings per share (EPS), the figure has been growing at an annual rate of 52.02 percent over the past five years. Earnings will likely not be able to sustain that rate, but EPS for the full year is expected to grow at about 22.7 percent.
Management
The management team that has helped u-blox enter its high-growth phase is still intact. Fritz Fahrni has been the chairman of the board since 2008. He holds an engineering degree from the Swiss Federal Institute of Technology (ETH), from which u-blox was spun off, and a Ph.D. from Illinois Institute of Technology. He was previously the CEO of Sulzer, a large Swiss industrial company, from 1988 to 1999. He then served as a professor at ETH Zurich and University of St. Gallen until taking the position at u-blox. He is also a board member of LEM Holding AG, Ammann Industries, Emerald Technology Ventures and Balgrist University Hospital.
Thomas Seiler has been both the CEO and member of the Board of Directors since u-blox’s incorporation in 2007. Overall, he has been the CEO since 2002 and was previously head of Marketing and Sales. He holds a mechanical engineering degree from ETH Zurich and an MBA from INSEAD, France. Before joining u-blox, Seiler was the CEO of Melcher Holding AG from 1991 to 1998 and CEO of Kistler Holding AG from 1999 to 2001.
Valuation
With the latest earnings report, u-blox has earned CHF 3.99 for the past twelve months giving the stock a P/E ratio of 31.50. The stock is fairly priced according to its median P/E ratios even after its triple in price from the start of 2013 to March of this year. The 5-year median P/E is 32.7, and its all-time median P/E since its IPO in 2007 is 31.9. According to the GuruFocus DCF Calculator, earnings would need to grow at a rate of 21.53 percent to justify its current valuation. Earnings increased 44.3 percent in 2013 but have only increased at a rate of 18.4 percent for the first half of 2014 compared to the first half of 2013. The company’s outlook includes an expectation of CHF 264-275 million, a 22.7 percent increase. The outlook did not include EPS, but margins have been stable so there should be a similar increase in EPS.
Risks
Of course nothing is risk free. For a while in 2012, the stock was trading at a P/E ratio of slightly less than 15. If multiple contraction happens again to that same level, the price would be cut in half. In the longer term, if u-blox keeps increasing earnings at a high rate, the price of the stock will follow along with its earnings. Since u-blox is a small-cap technology company, a much larger company could spend more on R&D to develop more advanced products. Also, since u-blox is a fabless company, it is at the risk of its manufacturers. The manufacturers are large, stable companies, but there is always the risk of production problems that cannot be controlled by u-blox. Technically, the stock has been trading in a range between CHF 100 and CHF 127 since the start of the year. If the trend continues without a breakout to the upside, it could drop to near the bottom of the range.
Outlook
U-blox is a company that has been overlooked in the recent Internet of Things megatrend. It provides the hardware that is needed for machines to communicate with each other and be able to understand its own positioning. The IoT is expected to be the third wave in the development of the internet after the fixed internet wave in the 1990s connected 1 billion users and the mobile wave in the 2000s connected another 2 billion users. The IoT has the potential to connect as many as 28 billion “things,” according to Goldman Sachs. U-blox designs and sells the positioning and communications hardware that will help connect all of these “things.”
On top of its product potential, the company has a strong balance sheet with no long-term debt and has been financing its new acquisitions mostly with its own free cash flow. Although the company has tripled in the past couple years, there is still more room for growth. It still only has a market cap of CHF 811.46 million (U.S. $936 million). The rapid annual growth rate in EPS of 52 percent over the past five years will be extremely difficult to replicate, but the company is still expected to grow 22.7 percent for the year.
A Global Member at GuruFocus will give you the ability to scan the markets in Europe to find more potential investments and provide full financial data that is difficult to obtain elsewhere. Other global markets available include Canada, U.K./Ireland, Asia, and Oceania. Along with the global data, I also used the All-In-One Screener to customize my search and save it, so I can periodically scan the markets to see if any new opportunities appear. As far as guru trades, no one has bought u-blox yet, so I will be watching to see if there is any activity.
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