Smith Micro: Riding A New Trend & Making Its Latest Comeback

Summary

  • Smith Micro’s (SMSI) acquired iMobileMagic and gained instant positioning in the market for mobile Family Protection apps. Anyone who has heard about the recent rumblings at Apple know that mobile Family Protection is becoming a topic of interest for 2018. When coupled with SMSI’s Internet-of-Things (IoT) capabilities and wearables strategy, it’s becomes clear that the company is looking to leverage the latest technology trends in an attempt to regain its past relevance.
  • SMSI has already secured a deal with Sprint, which management says will go live in February, leading to $14 million in annual subscription revenue and a turnaround in profitability.
  • SMSI has also signed a number of other tier-1 carriers, providing the potential for a long-awaited rebound in the company’s fortunes.
  • Due to its proficiency in selling to carriers, SMSI’s model exhibits high operating leverage, leading to volatile swings in earnings growth and commensurate bull and bear cycles for its stock.

 

Long-time readers should note some significant changes in how I communicate in the public domain. The sole purpose of this forum is now to attract new contacts with professional industry expertise to share research and receive feedback (confirmation / refutation) regarding my investment theses. Accordingly, this document should not be construed as an endorsement or recommendation of the companies or securities discussed herein. I am not an investment advisor and this is not an investment thesis. It is merely one part of the story, which I present for debate in hopes of determining all risks and upside potential. The disclosure at the end of this piece is critical to understanding the content of this document. Further, I frequently trade my positions and may buy, sell, or short the securities mentioned herein at any time, regardless of the facts or perceived implications of this article.

 

Introduction

It’s amazing how quickly an acquisition can change investor perception of a company’s stock. Helios & Matheson (HMNY) provided a powerful example of this when they acquired a majority stake in MoviePass last August.

But the devil is in the details.

It’s always a challenge to predict which products will go viral, but even more chalenging to go through all the SEC filings ad numbers to figure out which ones will drive profitability for the company (and profits for shareholders… a.k.a. ME!

Recently, I learned about an acquisition that is already starting to pay off for another mobile app /consumer service provider — Smith Micro (SMSI).

However, unlike HMNY, management has guided to near-term profitability and are proving it with their actions and numbers. They have a number of profitable customer signings, including an annually recurring 8-figure contract in hand.

This article will explore the company’s potential (to be clear, it does not offer a recommendation or price target). I invite discussion and debate on this topic in the comment section below.

 

Smith Micro: The Most Cyclical Stock I’ve Encountered

Before digging into SMSI’s current situation, it’s important to understand its historical modus operandi. I have tracked Smith Micro on and off since its IPO in 1995. During that time, Smith has always been a provider of enterprise-grade applications to telecom carriers. This has made the company (and its stock) highly cyclical and “hit driven”.

Hit applications that attract strong demand from carriers have historically driven significant capital appreciation for SMSI shareholders. Conversely, meager times have resulted in a slumping share price.

As you can see below, the stock has oscillated wildly (pun intended… figure it out) over the years (all figures in this report are split-adjusted).

After its 1995 IPO, Smith peaked at $74.00 (in 1996). It then bottomed at $2.52 (-97%) in 1999. Then it rocketed to $128.00 in 2000 (+4,979%), cratered to $0.68 (-99%) in 2002, rebounded to $84.80 (+12,370%) in 2007, corrected to $14.56 (-83%) in 2009, and topped out at $68.12 (+368%) in 2011 before falling all the way back to $0.80 (-99%) earlier this year.

SMSI1
Source: FreeStockCharts

Of course, these moves can be at least partially attributed to speculation, but the fundamental elements were unquestionably there. SMSI’s 2006 high of $76.04 was accompanied by a near-doubling of net income (and EPS of $1.51 per share). Based on its enterprise value (EV), the resultant P/E was 41 (reasonable for that level of EPS and earnings growth, though pricey for a cyclical issue).

Similarly, SMSI’s 2009 high of $51.48 preceded 2010 revenue of $130.5 million and 160% growth in net income to $12.3 million ($1.44 per share) yielding a P/E ratio of 29, based on its $350 million enterprise value at the time.

This article will explain why I can envision (not predict or guarantee… remember, I’m only sharing research and opinions for the sake of collaboration here) SMSI’s net income returning to those levels. It’s important to note that SMSI’s enterprise value is listed at $40 million, but likely closer to $50 million on a fully-diluted basis. Either number is near a historic low (and with good reason, as I’ll explain).

Strong earnings were the common denominator in 2006 and 2009. Recently, none of Smith’s products have been able to drive its bottom line. However, the addition of SafePath might (again, no prediction or guarantee… just sharing research for the sake of collaboration) change SMSI’s fortunes. I’ll review what management has said publicly and what it will mean for the company if they’re right.

SMSI2.pngSource: Smith Micro Investor Presentation, Dec 2017

I will also provide my opinion on the potential impact of the company’s recently-discussed interest in selling off components of its product line-up (most likely QuickLink, Captivate, and NetWise). If I’ve read management’s comments properly, any divestitures should to aid SMSI’s balance sheet and profitability, potentially sparking a new cycle of strong earnings growth and freeing resources to build on SafePath’s recent wins.

Because of this, I’m not surprised that CEO Bill Smith recently upped his stake from a reported 13.5% to 29% (something he disclosed at a recent LD Micro Conference). Institutions are already involved as well. However, total institutional ownership stands at just 15%. This leaves plenty of room for growth (in my opinion), but it’s effective float now stands at just 10 million shares.

Incidentally, on the Q3 earnings call Mr. Smith said:

I fully believe that we are well on our way to returning Smith Micro to growth and profitability in 2018. And to drive that point home, my wife and I have invested millions into Smith Micro. We are looking for a very solid return on our investment.

Based on his investment, along with recent events and company disclosures, it appears that SMSI is setting itself up to make another cyclical run. However, this time, the company seems bent on building a more sustainable platform for recurring revenue, growth, and profitability.

Specifically, last summer, Smith Micro announced the acquisition of Portugal-based iMobileMagic, developers of a next-generation suite of family safety applications for mobile platforms. As I’ll soon discuss, this offering has already been adopted by several large carriers around the world.

The Emerging Market For Mobile Family Protection

Smith Micro was attracted to iMobileMagic’s family safety offerings, dubbed SafePath for good reason. By marrying iMobileMagic’s innovative suite with SMSI’s connections in the telecom space, CEO Bill Smith believed he could spark SMSI next resurgence.

The SafePath platform includes parental controls for restricting how children use their smartphones (including phone number restrictions).

It also uses location services to track where they are and delivers alerts for “important location-based events, such as when a child arrives at school or arrives home after school”.

This is a large and fast-growing global opportunity. In 2004, only 45% of 12-17 year olds in the United States owned a mobile phone. By 2010, that number had risen to 75%.

Now, the average child is getting their first smartphone when they’re just 10 years old. It was recently determined that 50% of 3rd, 4th, and 5th graders (roughly 7-11 year olds, with a median age of 9) have a cell phone.

This is a boon for communicating with (and tracking) your children. However, the dangers of childhood smartphone use is shaping up to be one of the hot topics for 2018.

David Pinsen recently discussed this on Seeking Alpha. He also wrote about two of Apple’s (AAPL) institutional investors who have urged Apple to study the “research effects on young people of smartphone overuse and addiction”.

More recent research includes:

  • The impact of Facebook on mental health
  • Allot Communications (ALLT) expects that carriers will play a growing and significant role in providing security services to their customers. From what I’ve gathered, they actually seek to offer a much broader set of services.
  • The shocking eye-opening book, iGen (which I’ve been reading), exposes the impact that smartphones are having on today’s youth… and it’s simply stunning.

According to Smith Micro, SafePath arms customers with the ability to address child safety, cyber bullying, smartphone usage, and content controls (along with elder care and device theft).

SMSI3.pngSource: Smith Micro

The merits of monitoring/tracking your children (along with aging parents) should be well-understood by all. However, most may be shocked by how severe the problem has become.

For example, according to the New York Times, up to 15% of U.S. kids are chronically absent from school.

SMSI4.png

More worrisome are the statistics on cyberbullying.

According to recent studies, about 40% of children obtain a social media account before they turn 12 (25% of which are under 10). 87% of childrenhave witnessed cyberbullying. 40% of them have been experienced it first-hand.

The impact is even more concerning. Last year, TeenSafe reported that 83% of victims felt that the bullying hurt their self esteem. 30% “turned to self harming behaviors” and/or having suicidal thoughts… and a third of them actually attempted to take their own lives.

SMSI5.pngFamily Location apps (just one segment of the overall Family Safety market) have already attracted more than 70 million customers in North America and Europe, up from 16 million in 2011.

However, in a world with billions of children (and a spiking number of elderly people), 70 million users represents a blip on the proverbial radar. In the U.S. alone, more than half of Americans aged 18-40 have children.

Due to the evolving threats I’ve discussed, demand for a broader range of capabilities is on the rise… and penetration remains extremely low. For proof, just ask around to see how many parents (and adults who have aging parents) are utilizing anything more than location tracking.

Indeed, the industry remains in its early stages. However, all signs point to an imminent inflection point. When announcing its acquisition, Smith Micro stated:

With increasing awareness of threats to personal safety, ranging from neighborhood crime to national security incidents, Smith Micro believes the market is ripe for dramatic growth.

Already Doing Business With Major Global Carriers

At the time of Smith’s acquisition, iMobileMagic had already won deals with O2 in the UK (owned by Telefonica, which has 25 million total cell phone subscribers), MEO (Portugal Telecom: over 6 million customers), and one of T‑Mobile’s territories in Europe (owned by Deutsche Telekom).

The company also had two Asian carriers in deployment, which were later revealed to be Digi in Malaysia (which has 12 million mobile subscribers) and AIS (with 40 million subscribers) in Thailand.

It didn’t take long for SMSI to accelerate SafePath’s momentum. During Q1 of 2017, Smith Micro signed a third Asian carrier in Malaysia. Then, during Smith Micro’s Q2 call, Bill Smith stated:

We’re excited to share that we successfully launched our SafePath family offering in Latin America with one of the world’s largest Tier 1 carriers. This is Smith Micro’s first significant win for SafePath. We are bringing comprehensive location tracking and parental control services to subscribers through our SafePath Family platform. This service launched during the second quarter is offering subscribers innovative tools to combat the acute challenges of modern society, such as child safety, cyber bullying, mobile device and content controls, elder care and device theft.

And now things get even more exciting. I am very pleased to announce that we have signed our first Tier 1 carrier in the United States. As is the case with each of the U.S. Tier 1 carriers, this new customer relationship provides the opportunity to transition a large, already installed base of Family Safety users to our SafePath platform. This fact allows us to forecast a growing revenue stream of predictable recurring revenue over the contract term.

He went on to say:

But there’s more. We have been awarded another SafePath win, this time in Europe with a Tier 1 carrier with a global business platform. We are working to have a signed contract with this new customer in Q3 and begin deployment as soon as possible.

Two months later, in October, Smith announced that its Tier-1 U.S. customer was Sprint (S), which boasts 55 million wireless customers. The deal promises to bring $14 million in annual subscription revenue, a number that should grow as market acceptance expands.

On the Q2 call Bill Smith hinted that the Latin American win was with “one of the world’s largest Tier 1 carriers”. He also hinted that supporting Spanish was an area of focus. Triangulating these data points against the list of Tier 1 carriers on Investopedia, we can speculate (only speculate) that the other two wins may be with Telefonica (possibly an expansion of iMobileMagic’s win at Telefonica’s O2) and Carlos Slim’s America Movil.

That would be potentially exciting news, since those two carriers have a combined 10x more subscribers than Sprint.

As you can see from the list of the world’s largest carriers below, Smith’s eight-figure win at Sprint might merely represent a tip-of-the-iceberg type of deal. Indeed, Sprint garners just 3% of the wireless carrier market worldwide.

  1. China Mobile (China: ~850 million customers)
  2. Verizon (US: ~150 million customers)
  3. AT&T (US: ~140 million customers)
  4. Vodafone (UK + 25 countries: ~450 million customers)
  5. Nippon Telegraph & Telephone (Japan)
  6. Softbank (Japan)
  7. Deutsche Telekom (Germany & 50+ countries: over 100 million customers)
  8. Telefonica (Spain + 20 countries: over 300 million customers)
  9. America Movil (Mexico / Latin America: ~280 million customers)
  10. China Telecom (China: ~200 million customers)

Overall, the wireless market is $250B in the U.S. and $1T globally.

Three months later, SMSI’s Q3 earnings call was perhaps punctuated when CEO Bill Smith provided this subtle, but powerful data point:

I also want to note the advantages of SafePath which allowed us to win the Sprint business… which are important, as all Tier-1 operators in the U.S. are using the same legacy system as Sprint.

There are many reasons why that quote could be critical to this story.

First of all, Sprint has chosen to replace its legacy system with Smith’s solution.

They decided to make the shift even though their existing solution was the most-downloaded and highest-rated among the four major carriers (perhaps due to Sprint’s customization of the core system). In other words, Sprint wasn’t happy just being ahead; they wanted to attack this opportunity with a next-generation solution.

SMSI6.png

SMSI remarked on its Q3 call:

A particularly positive comment I would like to share is from the Engadget article and I quote, ‘while all major cell providers have some sort of parental control apps like AT&T’s Smart Limits or Verizon’s Family Basically, Sprint has leapfrogged them all with even more features. The company just announced Safe & Found, a new service that adds in real-time location, geofencing capabilities, an SOS button, and a way to find, lock, and wipe any phone if lost or stolen.

Smith isn’t resting on its technological laurels though. CFO Timothy Huffmyer informed me that Mr. Smith has been pushing his development team to continue advancing the product’s accuracy and feature set. Mr. Huffmyer himself has been testing SafePath with his own family. He says that he has multiple geofences set up, has been receiving regular alerts, and is pleased with the value SafePath is providing to him and his family.

Thus, it’s safe to assume two things:

  1. If Verizon, AT&T, and T-Mobile U.S. wish to compete in this burgeoning market, they’ll need to offer much better solutions than they have to date.
  2. The carriers have been using the same core engine, so there’s no reason they can’t all move to SMSI’s SafePath, as Sprint has.

Either way, if the carriers wish to remain competitive, they’ll have to upgrade to something new. At LD Micro, SMSI management hinted that the carriers’ old solution started falling behind when the developer was acquired by a larger company.

I have since learned that Location Labs is the vendor being used by the other U.S. tier-1 carriers. Back in 2014, Location Labs was acquired by online security firm AVG for $140 million plus a promise to pay an additional $80 million if “certain performance metrics and milestones” were achieved.

At the time, Location Labs reportedly had “more than 1.3 million” paying subscribers, was profitable and generating an estimated “$33 million in annual revenue”. That equated to a valuation of 4x revenue (which might be instructive in helping us to value SMSI).

More recently, AVG was acquired by Avast. From what I’ve gathered, this led to Location Labs getting lost in the shuffle and falling behind in product development (giving Smith the opening to win Sprint away).

In the meantime, SMSI’s recent wins might possibly be (no prediction; no guarantee) enough to support years of growth. Time will tell…

Smith Is Not Alone

While Smith’s solution has undeniably gained momentum, they’re not the only kid on the block.

In addition to Location Labs, Life360 has emerged as a top player in this space. It was founded some 10 years ago and has attracted about $85 million in funding to date. Most notably, Life360’s 2014 round of financing included $25 million from home security giant ADT at a reported $250 million valuation.

The good news for U.S. carriers (and SMSI) is that Life360 hasn’t run away with this emerging market. In fact, if you check out the spec sheet and independent reviews, the SafePath platform is actually appears to be more complete:

SMSI7.png

The last checkbox in the graphic above is arguably the most important. White-labeling means that SMSI’s platform can be individually branded by carriers. This is important because carriers have over 400 million mobile customers in the U.S. alone.

This could give SMSI a distinct selling advantage… and as Mr. Smith stated, they are all using the same legacy system that Sprint (which holds just 13% U.S. market share) just replaced with SafePath.

In other words, Smith’s U.S. opportunity is more than 7x larger than its Sprint deal, growing fast, and is ripe for the taking. Add that to the iMobileMagic’s pre-deal customer base, along with SMSI’s Spanish-market deals listed above and we can envision a viable path to garnering 18.5x more revenue than the Sprint deal can bring. For sure, it’s a long way from here to there, but there’s no denying a “viable path”.

It’s not a stretch if one examines the financials of LifeLock. LifeLock is known to be a leading provider of Identity Protection. At last check, quarterly revenues exceeded $170M (roughly a $700 million annual run rate). At that point they were acquired by Symantec (SYMC) for $2.3 billion (or 13.5x revenue).

The incentive for global carriers extends beyond the surface opportunity. It’s well-known that they want to lock in customers and take advantage of their incumbent positions. The Cloud giants (Amazon, Google, Microsoft, and IBM) have been encroaching on their turf with modern cost-effective infrastructures. Carriers have been scrambling to keep up — something I discussed when recommending Radcom (RDCM) via Seeking Alpha at $11.

Providing Family Safety solutions is a great way to lock in entire families. Based on the market trends discussed above, Family Protection is a prime candidate to augment the carriers’ position. Smith has many potential advantages in signing partnerships, including:

  • Decades of experience in working with and developing apps for tier 1 carriers around the world.
  • An installed base, which provides the R&D firepower to invest, improve, and evolve the SafePath platform.
  • A dedication to thought-leadership in the marketplace. As stated on the Q3 call, “You will see in the coming quarters that SafePath will continue to progress with new feature upgrades, the expansion of addressable markets and most importantly, the addition of new customers on the platform. As you can see, there is a lot of potential ahead for the SafePath solution.”

Specific to the current SafePath platform, Smith also seems to have inherent and growing advantages:

  • Smith is evolving its family location offering to include parental / browser control and other key features.
  • SafePath has the ability to support language localization (i.e. Spanish), which shoould make it easier for Smith to expand internationally.
  • SafePath “provides for extensibility to support new features, functionality and devices such as wearables”, such as GPS watches for children, pet trackers, panic buttons for elderly family members (as well as children), and biometric / fitness devices.

Investors shouldn’t underestimate the opportunity for pets and especially elderly family members:

SMSI8.png

I know this all too well. Last year, one of my uncles wandered off and wasn’t found until it was too late.

The good news (for everyone) is that SMSI’s entire SafePath platform can be deployed on carrier networks, extending those carriers reach into the Internet of Things. On this topic, Bill Smith had this to say on the Q3 call:

(this) represents a big opportunity for Smith Micro. As the wearables market is in its infancy, based on interest that is coming from carriers, we believe it is a market ready to explode. Our SafePath offering provides carriers a single, easily integrated platform to bring wearable devices to life.

Running The Numbers

Anyone following SMSI over the past few quarters has witnessed ample evidence of a turnaround. Q2 featured a significant restructuring which reduced SMSI’s operating costs by approximately 33%.

Expenses are now down to ~$5.6 million per quarter. This number is not expected to increase markedly, even as revenue growth reaccelerates, because SafePath related ramp-up costs were incorporated into SMSI’s new expense structure.

Thus, with gross margins at 80% and trending upward, SMSI’s break-even point has been reset to around $7 million in quarterly revenue (versus the $5.9M and $5.8M posted during Q2 and Q3 respectively, neither of which included significant revenue from its iMobileMagic acquisition).

On this front, Mr. Smith commented, “We have made the difficult decisions necessary to align our expenses and position the company for breakout growth.”

On the Q3 call, SMSI disclosed that Sprint’s legacy offering is due to sunset in the first half of 2018. At the LD Micro Conference, Mr. Smith validated reiterated / this. When that switch-over occurs, customers will be transitioned to SMSI’s SafePath platform, entitling SMSI to the the revenue boost it discussed on the Q3 call:

Sprint has a very sizable installed base of their legacy application which was location-based only. It did not have any parental controls built in. With SafePath, they get both within the same app. So there is a substantial growth in capability that this Sprint user will get to realize.

And so the first step is to get their installed base moved over to our platform and when that installed base is moved over and we expect some breakage along the way, but when that installed base moves over, that’s where we can see that the SafePath launch will add $3.5 million and up on a quarterly basis. Now in concert with that, Sprint is also looking to substantially increase the size of their family safety user base.

They think they have the best solution available here in the U.S. and they want to capitalize on that. So, they are working on a number of different things, programs that they are going to be launching that are totally designed to add more users to their platform. Clearly, that’s even better news for us. So, I think this is just the beginning and we’ll build over each of the quarters of 2018 and should bode extremely well for us.

So, once this deal kicks in, management expects it to generate over $14M of annual recurring revenue, which it hopes will grow as more aggressive marketing and market awareness takes hold.

According to both, the CEO and CFO, about 70% of SafePath revenues should drop straight to SMSI’s operating profit line. As mentioned above, the company just restructured and has minimal incremental expense requirements (they left some of the infrastructure in place to support its anticipated SafePath needs and commissions on new sales are expected to be “minimal”, per Mr. Smith).

SMSI also has an $80 million deferred tax asset, stemming from federal and state net operating loss carryforwards of $134.6 million and $147.5 million, respectively, as of December 31, 2016, so those operating profits should substantially drop to the net income / EPS line.

If they execute against their rhetoric (always a challenge) incremental gross margins should be in the 90% range, enabling incremental operating margins in the 80% range.

This is the power of operating leverage, which is among the most attractive characteristics of software companies. The key is scaling one’s installed base, which SMSI has traditionally done by signing carriers with tens of millions of customers.

It all goes to explain why SMSI’s booms and busts have been so pronounced.

When management’s figures are added to SMSI’s current revenue/expense base, we derive the following income statement:

Revenue September Quarter Sept Qtr + Sprint
Total Revenue 5,804 9,304
Cost of Revenue 1,159 1,859
Gross Profit 4,645 7,445
Selling & Marketing 1,413 1,600
Research Development 2,100 2,180
Selling General and Administrative 2,220 2,300
Non Recurring -146 -146
Total Operating Expenses 5,587 5,934
Operating Income or Loss -942 1,511
Loss on related party debt extinguishment -405 -405
Interest & Other Expense -317 -317
Income Before Tax -1,664 789

Of course the restructuring benefit is non-recurring, so that gain should be backed out. Similarly, the loss on related-party debt extinguishment should also be treated as non-recurring. Lastly, SMSI has a massive tax asset, so it wouldn’t be paying any significant tax in reality.

Netting it all out, if our assumptions are correct, SMSI should (no prediction; no guarantee) generate profits of ~$1.1 million per quarter (all else being equal) in the back half of this year. In other words, Sprint could be adding about $2.5 million in quarterly revenue / cash flow to SMSI’s bottom line (and growing, as/if Sprint expands its marketing efforts).

Multiply that by four quarters and we get $4.4 million of annual profitability. Meanwhile, the company less than 20 million fully-diluted shares outstanding and net cash of $4 million.

I’m not going to comment on what I think its valuation should be, to avoid the perception of pumping the stock. You folks can discuss that in the comment section below.

The one thing I will say is that if they do achieve $4M+ in annual profitability from the Sprint deal as is, that figure doesn’t account for any growth in or outside of Sprint. Nor does it account for revenue they might garner from product expansion (for which management has expressed aspirations), nor further expense cuts / proceeds from divestitures.

In other words, they have many avenues by which they can expand.

By the way, based on discussions with management, I believe the divestitures would involve unprofitable product lines. If accurate, SMSI’s profitability outlook would be further enhanced (even before accounting for any additional growth). Mr. Huffmyer also suggested that the proceeds of any sale could be used to find and acquire “the next SafePath”.

But let’s not get ahead of ourselves or count our chickens before they hatch.

Of course, the odds of additional wins and growth does need to be factored in. From this perspective, I believe (just me opinion) that there are four key drivers (aside from expansion of its product set):

1) Sprint – According to SMSI, Sprint switching to its platform isn’t a tactical move. A “noticeable” marketing campaign is being planned to accelerate the carrier’s success to date. Mr. Huffmyer provided a rough guess that Sprint has averaged about 100,000 new customers per year, but wishes to fast track its subscriber count towards 2 million (from what I estimate to be 350,000 at present).

Based on what we’ve bee told thus far, if Sprint adds just 100,000 subscribers per year, it would presumably add about $3 million to SMSI’s annual net income (based on management’s cost-structure information).

What that would mean for the stock is up for discussion below. I don’t want to count those chickens either, because the numbers could start to look incredulous, regardless of the fact that SMSI has achieved even higher levels of revenue in the past.

Incidentally, SMSI believes (per Mr. Huffmyer) that it could also supply marketing services for Sprint’s offering, which potentially represents a separate and incremental opportunity for this and other accounts. He told me that this might be especially valuable for winning Tier-2 and 3 accounts, which possess inferior marketing capabilities relative to the Tier 1s.

2) Over The Top – Smith has reportedly been focused on integrating SafePath into Sprint’s billing system, etc. Because of this, the platform has not yet been optimized for sale via Apple and Google’s app stores. This explains its exclusion from most competitive analyses of available apps.

That should change before year end, if management is to be believed. Completion of an over-the-top version is reportedly on the product road map for 2018. This would enable direct selling to consumers, as well as an intuitive path for Tier 2/3 co-marketing arrangements.

3) New Greenfield Accounts – In addition to the Sprint displacement deal, SMSI has been winning deals with other Tier-1 carriers around the world. Smith’s Tier-1 deal in Latin America was signed in July and launched in September.

Meanwhile, the company is working on a multi-country contract with the aforementioned European Tier-1 customer (which also operates in the Middle East and Asia). The company indicated that the official contract should be finalized in the next few weeks, enabling an announcement by or before its February earnings conference call. This deal is expected to go live in some of the carrier’s more affluent European jurisdictions in early 2018.

I believe that these Tier-1s are larger than Sprint. Intuitively speaking, they should also have the ability to attract over 100,000 customers per year, if that is indeed what Sprint has done. If so, Smith could be able to double its subscriber count in the first 12 months after Sprint is fully up and running, with calculable implications for its top and bottom lines.

4) U.S. Tier-1 Carriers – Technically, Verizon, AT&T, and T-Mobile do not represent greenfield opportunities. All three already have an installed base in the Family Security market. If Sprint can displace Location Labs in these accounts, the subscriber ramp will be accelerated, as is expected at Sprint.

Looking at U.S. wireless market share figures, all three carriers represent larger long-term opportunities than Sprint:

SMSI9.png
Source: Statista

Management has already implicitly explained that Sprint is capable of rapidly impacting SMSI’s bottom line by approximately $10 million annually. Thus, using the market share table above, we can approximate the impact of its larger competitors.

Extrapolating the Sprint Numbers

In a recent review, Engadget said that Sprint’s Safe & Found app is “like Find My iPhone, Life360, and parental controls all in one app”.

Let’s take those piece-by-piece:

First, we can assume that the market for Find My iPhone apps is essentially zero — basically, a free commodity.

Next, I haven’t been able to find a market size / forecast for the People Monitoring market (the Life360 piece of the equation) but mobile workforce management (a subset of the People Monitoring market) is said to be a $1.5 billion market in Europe and North America alone. Incidentally, Mr. Smith endeavors to expand into workforce management, along with asset tracking and driver safety.

Finally, Parental Control software is currently a $1.5 billion market and expected to grow to $3.6 billion by 2025. Notably, the market is shifting from laptops to phones, so the growth rate will be even higher for mobile solutions.

These numbers suggest that we’re dealing with a market that’s around $5 billion in size. We can triangulate/validate this by looking at the number of households (82 million in the U.S.) and multiplying it by the monthly price of Sprint’s service ($7), which yields a $6.9 billion U.S. TAM.

Globally, there are about 20x as many families as there are in the U.S., but affordability and cell phone penetration has to be factored in. Luckily, we can simply look at worldwide consumer spending on mobile apps, which tells us that the Americas represent about 25% of worldwide mobile app spending.

Now, the U.S. is only a piece of the “Americas”. Thus, I would estimate that the U.S. only represents about 20% of the worldwide total, yielding a worldwide opportunity of just under $35 billion.

At this point, it should be evident that this exercise is unnecessary at this stage of SMSI’s maturity. Capturing even 1% of the opportunity would make SMSI a $350 million subscription company, assuming that all of this is true. Again, let’s discuss in the comments section below.

For now, I believe that it makes more sense to focus on the Sprint opportunity. With this deal alone, Smith’s subscriber count is liable to go from “minimal” to 400,000 quite rapidly.

It harkens back to when MoviePass announced 400,000 subscribers. However, the difference for SMSI is that it management is telling us that its customers will drive instant and better-scaling profitability… and that’s with Sprint having only achieved 3% penetration for a product which should be top-of-mind for most families.

Even assuming incremental operating margins come it at “just” 50% (far below the figures they’ve provided), it’s not inconceivable that SMSI could eventually drive $35 million in profits to the bottom line from Sprint alone (aided by its tax assets).

And that’s just Sprint.

For now though, we should remain mindful of the reality (which is game-changing enough) separate from the opportunity. One represents something that could/should fundamentally drive SMSI’s valuation, while the other might drive a speculative element if traders latch on to the story (something I have no intention to foster or condone — again, I am simply sharing my research and assumptions publicly, so they can be vetted by the community for accuracy, viability, and risks).

Conclusions

Leveraging 35-years of M&A experience and industry connections, Smith Micro appears to be vying for leadership in the emerging market for mobile Family Protection solutions.

If management is to be believed, we won’t have to wait long for product development enhancements or customer revenue. Deals have been signed, time-tables have been established, and financial guidance has been provided. If all goes according to management’s plan (assuming I have interpreted it accurately), SMSI will post an impressive profit turnaround for 2018 and have a clear growth path for years to come.

Will it? And where might the stock go if it does? Let’s explore those topics in the comments section below. Cheers!

Disclosure: I am long SMSI.

I wrote this article myself, and it expresses my own opinions. I am receiving no compensation for it, nor do I have a business relationship with any company whose stock is mentioned in this article.

The information in this article is for informational purposes only and should not be regarded as investment advice or as a recommendation regarding any particular security or course of action.  I am not a financial advisor.  Nor am I providing any recommendations, price targets, or opinions about valuation regarding the companies discussed herein.  Similarly, the disclosure above may state that I am long or short shares of the companies mentioned herein, but should not be construed as an endorsement of any particular investment or opinion of the stock’s current or future price. That disclosure is true as of the time the article is placed in queue for publication, but it is possible (or even likely) that I might be buying and/or selling the stocks mentioned herein immediately thereafter or at any other time, regardless of (and possibly contrary to) the content of this article or this website’s timing of its release.  The disclosure will not be updated following submission of the article and may be inaccurate thereafter.  Likewise, any opinions are as of the date of publication, and are subject to change without notice and may not be updated. I believe that the sources of information I use are accurate but there can be no assurance that they are.  I wrote this article myself and I receive no compensation for writing it.  All investments carry the risk of loss and the securities mentioned herein may entail a high level of risk. Investors considering an investment should perform their own research and consult with a qualified investment professional.

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26 thoughts on “Smith Micro: Riding A New Trend & Making Its Latest Comeback

  1. I love the numbers here. I am going to start to build my position. I was waiting on your report before I bought any shares, but now I wish I had started building earlier. This has the potential of being much larger than MoviePass.

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  2. Hi Mark, Thanks for the article. Has mgmt made this Tier-1 European deal public via another medium? And did they say that their Q4 CC would be in February? Last year the Q4 CC was in March. Thank You.

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    1. Hi Kenneth, I’m not sure how many mediums mgt has discussed the Tier-1 European deal, but it’s been discussed publicly, as well as in one-on-one meetings they had with investors at LD Micro. As for the Q4 CC, they haven’t announced a specific date to my knowledge. Early March is certainly possible.

      Cheers!

      Like

  3. Hi Mark,
    What types of deals in the past made SMSI rise up to $60 per share. Is this current growth and plan equivalent to those, or is it on a smaller scale. Is there anything that would prevent T-Mobile, At&T or Verizon from adopting this software.
    Rob

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    1. I haven’t revisited the specific deals (and can’t remember them, even though I’ve followed SMSI for a long time). That doesn’t matter through — we can’t view them as apples to apples. What was good for the stock then might not be good for it now (and vice versa).

      The important thing is what impact each individual deal has on the company’s financials (and what it might mean for their ability to sign more deals and perhaps enter new / complementary markets). In that regard, I’ve provided what I know, but don’t want to speculate beyond that to avoid the appearance of being promotional.

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  4. Feels like the barrier to entry is pretty low here and I am not so sure that what they have is all that special. I am not seeing the secret sauce that sets them apart.

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    1. Most applications have relatively low barriers However, very few vendors have access to sales channels. Smith has the channels (carriers answer Smith’s phone calls — they wouldn’t answer yours or mine, in my opinion)

      As a result, they quickly secured a deal that justifies further investment in the suite, which increases the barriers to entry (again, IMO).

      This is generally how it works out for software companies who find success. Sales + R&D investment builds scale which makes it harder for other companies to justify jumping in to compete.

      For a location-only app, the barriers are low, but the potential revenue is near zero. However, to build a broader carrier-grade suite, you’re talking about millions to get into the game.

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  5. Mark,
    I am looking at the Nasdaq website trying to find the huge insider transaction that you mentioned in your article. I am only seeing 6 small dispositions of stock by Mr. Smith over the last year. How can we verify this huge increase in ownership?

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      1. I am also seeing an S-1 filed at the end of the year for 6 million shares of common stock offered by selling stockholders including Mr Smith’s 3.5 million shares. Any updates on that filing?

        Thank you again for bringing this stock to our attention.

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        1. That just registers the shares that were purchased in the offering from a few months ago. That just means that those investors have the same right to sell that the rest of us do. It doesn’t mean that they are actually intending to sell.

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  6. Thanks Mark for the update on SMSI. Huge and I mean huge potential! A couple of observations: I was wondering how much they paid for the acquisition of iMobileMagic? I’ve heard it was around $3.5M which seems ridiculously cheap. If this is true it seems like this one acquisition has provided SMSI with this gangbuster opportunity. Is this a case of too good to be true? In other words, why did iMobileMagic sell out for such a low price? Also, they are getting very low on cash. It’s critical that they achieve profitability within the next six months or they will have to raise more funds. Lastly, I’m amazed at the history of wild rides this company has had. In this respect, California Amplifier (CAMP) reminds me of SMSI. I’ve made good money buying CAMP below $2 and $5 and selling for as much as 10x that amount. Even though there is no rational explanation, some companies have an uncanny knack for repeating history.

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    1. Great post. Yes… it was ridiculously cheap (IMHO), but they were based in Portugal and didn’t know how to sell to carriers effectively.

      However, that’s SMSI’s strength / differentiator. With so many apps being developed without a cogent sales strategy, I think there are a lot of opportunities for them to exploit.

      As for the cash, I’m not too concerned. The CEO owns 29% of the company, so he’s heavily incentivized to achieve profitability quickly or raise cash with minimal (if any) dilution (i.e. divestitures). As always, there are a lot of risks, but I think they’re nicely outnumbered by the potential rewards. Cheers!

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  7. Thanks Mark for the quick response…….makes sense about the acquisition price. I’d also like to point out that the CEO (Smith) is almost 70 yrs old. As you said, he’s owns a major stake in the company. Given that the stock has such a low float it will be difficult for him to sell his shares. I’ve got to believe he will be very motivated to sell the company when it makes sense. It certainly doesn’t hurt that they are in the midst of positioning themselves in a very hot part of the industry.

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      1. Mark, one giant red flag is the app for Safe and Sound has a lot of terrible reviews. I have not loaded the boat on SMSI……at least not yet. I remain unconvinced until they fix some of these problems.
        In reading some of the complaints, many people prefer the old app called Family Locator. There are many more bad reviews than good.
        reviews:https://play.google.com/store/apps/details?id=com.sprint.safefound&hl=en

        Have you spoken with management lately? Are they addressing these problems?
        Thanks,

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        1. I have. They’ve been showing up the acquirer product in recent quarters. I generally don’t worry (too much) about product quality (ditto for MoviePass)… software development can cure many ills.

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  8. Hmmm…..in reading some of the complaints, many of them are user errors or stupid complaints about the product. Maybe this is not an issue after all?

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    1. Bingo. Still an issue, but software bugs are generally reparable. This isn’t rocket science. The SMSI story is more about their sales-channel expertise (along with knowing how to take a non-carrier ready product and making it carrier ready).

      Liked by 1 person

  9. Hi Mark
    I have already bought a nice size position and with this sell off I am thinking of buying more but probably want to hear managements 4th quarter call first.
    Do you know when they will report 4th quarter numbers?
    Thanks

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    1. Probably early March. Smart strategy to buy in tranches. I’m waiting to hear more as well. I sometimes prefer to pay a higher price with more knowledge than a slightly lower price in the dark. Today’s news from SNAP was a perfect example. I read the transcript last night and felt that it warranted a greater than 20% move. Boy, did that pay off 🙂

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