What’s a Femtocell — $12 Billion Market by 2012?

Small-Cap Confidential pick from Tom Garrity

By Travis Johnson, Stock Gumshoe, October 21, 2009

Today we’ve got a bit of a teaser email from Timothy Lutts over at Cabot, for their Small-Cap Confidential newsletter. It’s got an interesting pitch with this “femtocell” business — he leads in by telling us how frustrated he is with dropped calls on AT&T near his home in Massachusetts thanks to the overtaxed network (which, in turn, is caused by the iPhone that he loves). As an iPhone user myself I can share some of the frustration, though I rarely have trouble down here in DC — but I do lose the signal in my house.

And a femtocell is apparently the solution. It’s a little cell transmitter thingy that apparently uses your broadband connection to connect to the phone network, instead of relying on a weak cellular signal in the bowels of your McMansion. I have no idea how or if it works, but they’re testing them in a few markets and Lutts tells us that he’s got a company that’s primed to do well in this market, even though the actual product isn’t yet a measurable market force.

Here’s how he teases it:

“My recommendation is an attempted home-run swing with an unknown little player in the femtocell market, a company whose revenues were just $4.9 million in the second quarter … mainly from non-femtocell electronics.

“The company, located here in Massachusetts, has been working with Alcatel-Lucent, Motorola, Hitachi, Nokia Siemens, Thompson Electronics and Pirelli … and most of all, Nortel. But Nortel filed for bankruptcy back in January, which not only slowed business down but also made the stock pretty cheap. Since then, Nortel’s relevant intellectual assets have been acquired by Ericsson (for $1.13 billion), and I have little doubt that Ericsson will be a big player in the femtocell market using this company’s technology.

“In the meantime, the company has been recently buying its stock back, a clear indication of how cheap management thinks it is. (It’s currently
trading around 7.) Another fan of the stock is Tom Garrity, editor of Cabot Small-Cap Confidential, who recommended the stock back in July, when
it was trading at 6.”

OK, so that’s a little slice of clue heaven — but there’s more, he excerpts part of Garrity’s recommendation letter to get us a wee bit more tantalized:

“The average operator’s core traffic, measured in terabytes, is up some 35 times in the past year. Data is flooding the network and carriers are struggling to stay afloat. [Company X] is here to teach them how to swim.

“[Company X’s] established relationships with the biggest players in the telecom industry have us imagining a day when its superior technology is
not only dominant, but ubiquitous. In other words, we think this company is setting a new industry standard. [Company X’s] wireless technologies
and its network management software are second to none. Investors have an opportunity here to get in at the beginning of a period of industry-transforming growth of a kind that’s not seen every day.”

So who is this little “home run swing?” Thinkolator sez it must be …

Airvana (AIRV)

As Lutts notes, it is headquartered not that far from his home turf in MA (they’re in Chelmsford, Cabot is in Salem), and this is a company that, although they work on a broad variety of technologies in the mobile broadband area, seems to be pretty focused on the potential of femtocell technology. If you’re curious about the technology and what it means, they give a nice pitch for it on their website here. And in order to draw more attention to the need for their products, they recently released a study that claims smartphones have eight times the network impact of regular cellphones — as probably most facebook-checking, app-downloading, web-surfing iPhone users would attest.

Airvana is profitable, but clearly priced for growth — they’re expected to close out the year with 27 cents in earnings this year, and analysts guess that they’ll earn about 40 cents a share next year, so the forward PE is right around 18 (the shares are still at almost exactly $7, and they were at $6 in July, as teased). Those numbers are from the analyst projections published by Yahoo Finance, Morningstar uses somewhat more optimistic ones and puts the forward PE ratio at about 14. The business is extremely seasonal, I assume because their customers do their buying at the end of the year — it appears that they lose money in every other quarter of the year and make it up with much higher sales in the fourth quarter, so over the last twelve months they’ve been, in total, unprofitable but apparently a big enough boost is expected this quarter to bring them to annual profitability.

So … I know that Airvana does work with all those partners that Lutts mentions in the teaser, that they are hoping to play a significant role in the femtocell market as well as in other mobile broadband technologies, and that they are on the edge of profitability and growing, though analysts have, over the last several months, brought estimates down for next year.

I don’t know if they’ll really be a great “home run swing” investment, but with decent growth forecast and a fairly reasonable forward PE for a small tech company in a growing sector (market cap about $400 million), I’ll confess that I’m thinking now about taking a closer look for my own account … and about maybe lining up to get one of those femtocell thingamajigs. The flip side, of course, is that in the telecom equipment sector things tend to get extremely competitive, and I have no idea as of yet how many femtocell players there are or if Airvana has any sustainable competitive advantage — if you’re a fan or foe of AIRV, feel free to let us know what you think with a comment below.

And we do not currently have any reviews on file for Cabot’s Small Cap Confidential newsletter, so click here if you’ve subscribed and would like to share your opinion — or you can see the reviews of other Cabot offerings here, they’ve got a couple letters that are pretty well-reviewed right now.