Cabot’s “Your Wealth in the Coming Era of Universal Connectivity”

By Travis Johnson, Stock Gumshoe, April 28, 2011

I’ve been resisting writing about this stock that Cabot is teasing for almost a year for their Small-Cap Confidential newsletter (edited by Thomas Garrity) — I started getting very similar teaser ads from them last July, as best I can tell, and the ad has continued to roll on, with minor variations, almost constantly since then.

That’s nothing unusual, to be sure — some newsletter shops might use the same teaser ad, picking the same stock, for years, and some of them don’t even bother to update the tease when the stock doubles, or gets cut in half … clearly the push of the marketing folks is: “if it works, work it to death.” Sometimes it’s hard to tell if the editor even really still likes the stock anymore, or they just know that it works to pull in subscribers.

But anyway, I resisted writing about this one because I could never make the specifics of the tease match up perfectly with the company that I think they’re teasing — it’s close, but not exact. Every time it rolls through, though, more readers write in asking about it … so I’m going to take another look (Cabot has updated the “clues” a bit, thankfully) and see if I can be any more definitive. Or, if I can’t be definitive, I’ll stray from my usual “99% certainty” and at least tell you who I think it is. Deal?

The pitch is that they have a special stock that sounds incredibly awesome:

“By Far the Undisputed Leader in Wireless and Device Connectivity

“This juggernaut provides the secure, persistent connectivity solutions every carrier, content provider and device maker needs.

“And it has absolute domination of its field. No competitors even come close.”

Enticing, right? No wonder they keep using this ad.

The basic spiel is that the company is the unassailable leader in the “next-generation communications revolution,” and that their products are pre-installed in wireless devices used by a billion people, and in three years they’ll be in four billion devices. Not many products get that kind of coverage — there are, after all, still just about seven billion people in the world (that makes me feel old — I remember being told that we were hitting four billion as a young child).

And then we get some more clues — here’s what they say in the current ad that I just got yesterday:

“Its sales have been growing an average rate of 51.7% a year for the past five years….

“Its founders control 16% of the company–a sign that management is highly committed….

“Every top mutual fund with a position in the company has increased its holdings since the middle of June 2010.

“Investor’s Business Daily called it ‘one of the top five companies in the … industry.'”

And there’s more — apparently this “seamless connectivity” is a key part of the product, the ad says that the product transitions users “seamlessly” from network to network. And a few more clues:

“The company’s flagship products are essential to over 40 carriers on over 200 global mobile networks.

“Its customers include all of the largest U.S. wireless carriers, including Verizon, Sprint and AT&T, and Dell Computer.

“Its overseas customers include British Telecom, Brasil Telecom, cell phone giants Samsung and Motorola, and Clearwire, the projected WiMAX network leader.”

And finally … the share price: They say that right now you can buy the stock for “about $8 a share.” So who is it?

They compare it to Microsoft or Cisco in the early days, but this company is quite teensy — the Thinkolator sez (and we’re actually pretty sure this time around, given the new clues … let’s say “97% sure” to be pointlessly precise) that we’re being teased to buy … Smith Micro Software (SMSI)

Which has been a terrible stock for the past year for long-term holders, it’s right near the 52-week low now at about $7.80, and the teaser train from Cabot seemed to start right around $10 last summer, though the stock did briefly reach $16 in early January (so it would have been possible to make a profit if you traded it well).

It’s certainly not expensive — it’s a small cap stock with very nice gross margins (though they spend a lot on SG&A and a lot on R&D, so overall margins are not so big), and it is profitable and has had positive earnings surprises for the last four quarters in a row. The PE ratio for the trailing year is 21, which is historically below average for them, and the forward PE is a respectable 10 according to most estimates … and the cash apparently does really come in, they also trade at about 10X cash flow, which is also low for them.

So on paper it certainly looks like a decent value, especially if you believe they’ll be able to leverage the penetration of their connectivity software to increase sales or margins. I have no idea if they can do that or not, but the stock has had trouble getting out of its own way — it has traded in a wide range from $5 to $15 or so for most of the last five years, and hasn’t ever really shown that it can turn their nice revenue growth into real consistent growing profits per share. Or maybe it’s just that the analysts don’t trust them to keep a hold on the share of the market that they own, I don’t know, I have quite a hard time figuring out this company.

They do continue to focus on connectivity software, something that goes back to their founding as a developer of modem and fax software before they entered the mobile space in a big way in the last decade or so (this is a software firm, not a chip company — I don’t think they sell any hardware), but they also have some consumer and other products, including some that I’ve used like StuffIt for file compression, and a bunch of art and graphics software packages that I’ve never heard of.

Still, I’m pretty sure this is a match for the Cabot tease — and given that newsletter publisher’s general tendency to push growth stocks, I find it interesting that they continue to push the stock hard (assuming I’m right) after it went from $10 to $16 and back down to $8.

The clues are very close — they don’t spend 45% on R&D according to their releases, but they do categorize 40%+ of sales as going to SG&A and 30%+ to R&D, and the founding family (the Smiths, naturally) control a big chunk of the stock — I can’t make the number come out to 16% exactly, but he and his trust apparently own a little less than 5 million shares (out of 34 million) according to the filings I’ve seen. Pretty close, and he did do a decent-size programmed sale of shares last year, so that number has come down.

Their basic connectivity software is apparently used for about a billion cell phones that have been sold, though I don’t see that as an “official” number from the company. Most of the mutual funds that hold these shares have increased their holdings in recent quarters, though there aren’t many major funds that hold shares (it’s a very small company, market cap under $300 million — one of the big holders, not surprisingly, is the Royce family of funds, which focuses on small and micro cap names).

And they are focused on new connectivity products, here’s the spiel from the CEO in the last quarterly release:

“‘Our solid fourth quarter performance contributed to closing out fiscal 2010 as a very strong year where we achieved both record revenues and profitability,’ said William W. Smith Jr., President and CEO of Smith Micro Software. ‘In addition to delivering outstanding financial results, during the year we embarked on several key new initiatives within the Company designed to put us in position to capture new opportunities emerging with the rapid adoption of broadband mobile data services along with the deployments of 4G next generation wireless networks.’

“Mr. Smith concluded, ‘We are encouraged by the early response to some of our key initiatives such as our Quicklink Mobile Hotspot Manager powered by our SODA (Secure on-Device API) that will bring a new level of manageability to the mobile hotspot users experience while enabling carriers and device manufacturers with increased efficiencies and velocity to market with these exciting new products.'”

Still, even a quick glance at the chart will tell you that something went very wrong with Smith earlier this year — they reported that they expect a major shortfall in revenue for the first quarter due to a major customer’s inventory glut, which doesn’t instill confidence. Here’s what the CEO said in the 4Q conference call about it:

“I’d like to comment on the revenue short fall that we are expecting in Q1 as reported a little over two weeks ago when we set Q1 guidance in the range of $15 to $20 million. As discussed in our conference call on February 9, we are facing a major unanticipated order short fall from a key customer due to an inventory backlog.

“We believe this issue will be alleviated overtime and we will get back to a normalize state of license sales to that customer. While we view this as a temporary setback, we are working to mitigate the possibility of this ever happening again. Aside from the continued product innovation that we expect will add new opportunities, we spent much of 2010 investing in establishing presence in markets – in new markets with the goal of expanding and diversifying our customer base.”

So … will Smith Micro Software recover from this, diversify their earnings and built out a big business with their new mobile products like their new mobile hotspot manager? Or do you think they’ll disappoint again? There are certainly other companies with similar-sounding products, like Motricity (MOTR), but I have no idea whether Smith has any kind of competitive advantage in developing new technologies or meeting customer needs.

It should be interesting to see what they say in their next quarterly release about how that first quarter really panned out, and about how the rest of the year is going to be impacted by that big customer’s inventory situation or their new products — I’d guess that the stock is likely to move in a reaction to whatever they say on May 4, when they’re scheduled to release earnings next, but I don’t, of course, know whether it will be a relief “it’s over” rally about growth returning or a “dammit” crash because the issue gets drawn out into future quarters.

Lots of you are smarter than your friendly neighborhood Gumshoe, though, so let us know what you think about SMSI or any better ideas in the “connectivity” space with a comment below. Thanks!

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3 Comments on "Cabot’s “Your Wealth in the Coming Era of Universal Connectivity”"

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@dreverts
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May 2, 2011 1:10 pm

there have been about 30k shares sold this year, which is relatively low for SMSI

neimak
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neimak
May 4, 2011 10:22 am

gamble, exactly Stu

lin
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lin
May 5, 2011 4:28 pm

Arrgh! SMSI really took a beating today. I'll bet those newsletter subscribers are not happy. It really looks attractive now, I might have to roll the dice.

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