What’s the #1 Internet of Things pick teased by Keith Schaefer?

by Travis Johnson, Stock Gumshoe | March 10, 2016 4:25 pm

The ad says this stock will boom either on a takeover, or as it benefits from massive spending on improving the electrical grid

“The next MegaTrend is here and ready to make a bundle from it.I just spent six months researching it, and I’ve dug out what I think is my greatest stock pick ever.

“My only concern is that this company gets bought out in the next six months.

“And that I miss out on its long term upside.”

That’s a quote that caught the eye of quite a few readers in a recent teaser pitch for Keith Schaefer[1]’s Oil & Gas Investments Bulletin[2]. Schaefer has been using stocks that are sort of on the edge of the energy sector in his ads of late, which perhaps makes sense — he built his newsletter using recommendations of little oil[3] and gas companies, and that’s obviously a far different sector, especially for the small players, after oil’s 70% fall.

Last time out it was an energy marketing company[4], this time it’s a “smart grid” and “Internet of Things” company. We’ve certainly seen plenty of pitches about the Internet of Things over the past couple years, hinting at everything from GE to little chipmakers, and there are hundreds of companies trying to catch that wave of expected growth, and there remains a pretty strong consensus among investors, as I see it, that the opportunity is huge and long-term in nature. Which makes sense, if you’re going to develop sensors, networks and data analysis methods to connect. monitor and understand everything from jet engine parts to refrigerators there are a lot of moving parts in that network… and in terms of sheer number of devices it’s a far, far larger opportunity than mobile phones (doesn’t mean there will be more profit, of course, that remains to be seen).

So what’s the stock this time? Well, the intro is really about the electrical grid, and it’s a company that has something to do with enabling the “smart grid” — which mostly, in this case, just means that electrical devices can communicate with each other and adjust energy consumption instead of just being “dumb” devices that are either on or off all the time. Here’s a bit from Schaefer’s pitch to give you a taste of where he’s coming from:

“In World War II, when the Allied countries laid out their first strategic bombing plans–the first target they selected was easy to agree on.

“It was the German electrical grid. The Allies knew that without electricity the Germans couldn’t do anything.

“If Germany had been attacking the United States it would have selected the exact same target. America’s most important asset was and still is its electric grid. The entire economy runs on it.

“Not much has changed with the U.S. electric grid since the 1940s. I don’t just mean how important it is…..I mean that literally, almost nothing about it has changed….”

“If You Aren’t Concerned About The U.S. Electric Grid… Pay Attention

“In 2009 the United States Department of Energy released a dramatic report that did not receive nearly enough attention.

“For it included a dire warning for the United States of America.

“Here was the main point of the report…

‘…the current electric power delivery system infrastructure…

Will be unable to ensure a reliable, cost-effective, secure and

Environmentally sustainable supply of energy for the next two decades…

…the current U.S. Electric power grid is nearing the end of its useful life.’

“… why don’t we ever here about this huge threat here at home?

“That the access to power for 320 million people is compromised.

“Of course the news is even worse than it seems.

“This report was written 6 years ago…

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“That means that we have only 14 years to go before we have major, major problems.”

[5]The problems are obviously not new, nor have they been ignored since 2009, but they are daunting, and from all I read it’s still true that our electrical grid is very susceptible to failure in lots of ways — too old, too inflexible, too many sensitive points where error or attack could bring down huge swathes of the grid, etc. (everyone uses the example of the Northeast blackout Many of the “smart grid” investments are designed to help that and to reduce peak energy demand, though many are also designed just to save electricity in general or otherwise increase efficiency.

So Schaefer’s argument, to simplify, is mostly that there will be massive spending over the next 5, 10 however many years to upgrade and improve the grid, and that a fair amount of that will go toward “smart grid” initiatives, sensors, networks, etc… which will benefit his favorite stock.

And here’s how Schaefer describes the broader marketplace in which his company exists, the “Internet of Things” and the opportunity therein:

“Have you heard of “The Internet of Things”?

“It’s where very small computer chips get put into EVERYTHING—home appliances, industrial equipment, and public infrastructure like streetlights and parking meters.

“Now we are going to know a) where everything is

“b) how much energy everything uses

“c) and when it’s about to die

“The savings in energy and inventory will quickly tally into the tens of billions of dollars—annually. Businesses and people are about to become much more efficient—and profitable.

“Global consultant McKinsey says the Internet of Things will be larger than the economy of Germany in 10 years–$3.8 TRILLION….

“This is going to be part of every aspect of how the world consumes energy.

“Perhaps most importantly it will allow for a complete remake of the ticking time bomb that is the U.S. electric grid.”

What is it? Here are the clues we get, sifted out of the long and repetitive spiel…

“All of my research and all of my contacts have helped me narrow that even more, down to the one small company I’m certain is the single best way to profit from this massive opportunity.

“It has over $100 million cash of its own, no debt, has installed millions of “Things” on this new Internet—and even created its own network.

“It’s going to be a massive winner for shareholders….

“The big boys are circling this company.

“I haven’t just heard rumors.

“I can see it in the way the stock is trading.

“It is called accumulation….

“The current market cap is under a billion dollars….”

Schaefer’s argument, in part, is that there will be so many hundreds of billions of dollars spent on upgrading the US electrical grid that you want to be in line with your hat out to catch a few of those bucks, but also that his favorite company is already establishing itself and has already put in place a large network of what he calls “endpoints” — which would be stuff like street light sensors, thermostats, whatever “things” are connected to the “internet of things[6]” in the context of the smart grid.

“My #1 Internet of Things stock pick is already several years into helping utilities[7] start to make the transition required.

“By doing so it has established a powerful first mover advantage.

“This game, this electric grid revamp is all about ‘endpoints’. That’s the slightly more technical term the industry uses instead of Things.

“Whoever has laid the ‘endpoints’ in place can’t be displaced.

“The more utilities that a company enters a contract with.

“The more endpoints are established.

“These endpoints are why this company is my #1 Internet of Things stock pick….

“The moat around this business is enormous.

“Once those sensors, those endpoints are put in place that business is won…

“A recurring revenue stream is established that will last for years….

“My #1 Internet of Things stock pick already has an Internet of Things network that has proven to have the highest level of security.

“This network has already connected more than 20 million devices and is proven.”

OK, so there are quite a few specifics that we can work with hidden in that language… but we do also get one more clue, about the CEO:

“This relatively small company was able to attract a very high profile CEO.

“A CEO who had a very lucrative job at a major tech company.

“Running its Internet of Things business.

“A job with a secure, large salary.

“A job that most of us would never leave.

“Yet this person did leave.

“To join my #1 Internet of Things stock pick.

“A much smaller company.

“Why would a high profile Internet of Things executive leave one of the world’s heavyweight tech companies to join a much smaller Internet of Things company?”

I don’t know if that kind of logic consistently holds water[8] — lots of higher-up execs at mega companies who know they’re not ever going to be the CEO of Microsoft, Google, GE, whatever leave to take over the top spot at much smaller companies. But it is, at least, a clue… and it’s probably a positive that they recruited an industry veteran.

So who is it? All signs point, sez the Thinkolator, to Silver Spring Networks (SSNI), which went public back in 2013. That’s one of the interesting examples of the “bubble” in venture-funded companies and the “going public doesn’t always make you more valuable” argument” — Silver Spring went public, before it was profitable, at a valuation of about $750 million… and it had been valued by private equity investors four years earlier at well over $1 billion (it has not done particularly well as a public company as of yet, the market cap today is about $670 million, though the share price (about $13.50 now) has almost doubled from the lows of about a year ago.

SSNI trades at what appears to be a seriously cheap valuation of 8X trailing earnings, but that’s a case of GAAP accounting making things look better than they are — their adjusted numbers, which include some big adjustments in working capital and foreign currencies and other stuff that I’m not sure I understand, mean that SSNI earned nine cents a share last year and, per their forecast, will earn something between five and 20 cents a share in 2016. If they hit the high end of that, that’s a forward PE of about 65.

They’re just turning profitable now (though next year the adjustment will flip — they’ll be profitable under non-GAAP accounting, but will lose money under GAAP accounting), and they’re not growing their net income very fast, but they are seemingly making some progress in building the business. You can check out their 2015 Investor Presentation here[9], or the full 10-K that was just filed here[10] if you want to see all the detail (the 10-K is much more illuminating in giving an understanding of the company, of course, but it’s also a bit of a slog).

How does it match our clues? Silver Spring has been claiming more than 20 million “endpoints” for a couple years (so the number is presumably above that now — they have been growing sales of those “endpoints” and selling a bit more than two million per year lately — and yes, they do create recurring revenue, at a rate, per the presentation, of a bit over $2 per year per endpoint… dunno how long that “recurs” for).

And they did recruit a CEO from big tech — their head is Michael Bell, who was a VP at Intel and worked in their mobile/connected device division. And they are primarily selling the safety, security and efficacy of their open source-based network for the smart grid (though they talk about other possible uses of this networking technology as well, perhaps trying to become a standard communications network for the Internet of Things in general). They are also “cash flowing”, though actual profits are new and unpredictable.

Will they become a huge force? I have no idea. Analysts are not predicting wildly optimistic near-term advances for SSNI (avg. price target is $15, and non-GAAP 2017 EPS forecast averages 34 cents, though the range is very wide), and the company itself has pretty tepid growth forecasts for this year — but they could surprise, or the longer-term opportunity could begin to excite investors, or, as Schaefer says he worries about, someone with a strategic long view could buy them out at a hefty premium. They’re in a bit of transition, it seems, and have been expanding overseas partly because of what seems (to me, at least, I have looked at the company for only an hour or two today) to have been a mad rush at the low-hanging fruit of “smart meters” in the electric grid that has now slowed or gotten too competitive and forced them to more substantially try to diversify into other sensors that use their network.

It would not be at all surprising if SSNI turns out to be pretty volatile — they are small, and they are very concentrated both in terms of their investor base and in terms of their customer base… a big deal with a utility could easily have a huge impact, their two largest utility deals right now together account for about 60% of revenue (a bit less than that for the non-GAAP numbers), and they still have a huge Venture shareholder, Foundation Capital continues to own about 25% of the company. My primary concern regarding SSNI would be competition — they do have customers, but the list of both startup and megacap competitors for establishing a “standard” for Internet of Things (or even smart grid) communication networks is pretty long, and I can’t guess at where SSNI sits on the continuum from “likely winners” to “also rans.”

So with that, I’ll leave you to your research and your thinking — does this look like a long-term grower to you? Like a short-term buyout candidate? Like junk? Something inbetween? Let us know with a comment below.

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