Saturday, February 9, 2008

Telular Report (WRLS)

WRLS Abstract -07/2007
At first glance, Telular Corp appears unimpressive, as the company has no profits in the past few years. However, with the introduction of Telguard digital products and a new FCC mandate, Telular stands to gain almost 400,000 customers by 2008, a growth of almost 200%. In analyzing the company’s cash flow, we see the stock is currently undervalued. Thus, I recommended that Telular is a Buy, as the company has great potential to increase its subscriber base within the next few quarters.

Introduction on Telular
Telular Corp is a micro cap communications company. The company has two main product lines: the Fixed Cellular Terminals division (FCT) and the Fixed Cellular Phones (FCP) division. The FCP market is considered much more competitive than the FCT market. The FCT unit is poised for the strongest growth in the wireless security segment.

Telular’s important product, Telguard, provides wireless communications for security systems and acts as a backup when a telephone line is cut. In FY 2006, Telguard experienced a growth of 232% in sales, increasing it to $21.6 million. The driver behind this growth is the introduction of the Telguard digital products. Driven by the sale of more Telguard units, service revenue from the FCT division increased 23% to $11.1 million for the 2006. The competition comes from Ericsson Radio Systems, Huawei Technologies, and LG Electronics (Annual Report 2006). Competition for the wireless security market also comes from AES-InteliNet Corporation, which provides communication through a free wireless mesh network. This could pose a significant challenge to Telular as unlike Telular, AES-InteliNet’s network does not require a subscription fee. The company has 25 patents along with 5 pending patents that can help provide successful barriers to entry in this competitive market. Currently, Telular is the only company whose product can work with any alarm system.

Future Prospects of Telular
At first glance, the company appears unimpressive, as it has not had profits in the past few years. However, this may be about to change as the Federal Communications Commission (FCC) has recently ruled that after February 18 2008, wireless carriers will no longer have to support analog devices that provide backup wireless security. According to the Q1 conference call with Telular, approximately 600,000 to 1,000,000 homes will have to be upgraded to the digital standard. Telular may gain from this transition as new subscribers can bring in recurring revenue. Also, Telguard can act as a link for 911 services for those with VOIP service.
In Q2 of 2007, Telular had about 220,000 subscribers to Telguard, which translates to a 65% market share (Telular Investor Presentation, slide 12). Using the conservative 600,000 homes and a 65% market share, Telular stands to gain 390,000 new subscribers who are switching from analog to digital services in the next few quarters. Adding the current subscriber base to the projected new subscribers will increase the number of subscribers to 610,000. Furthermore, not only does Telular stand to benefit from a one-time increase in customers, but the market is continuing to expand since the digital cellular alarm communicator costs less. This allows for more penetration into the residential market. New subscribers grew in Q1 of 2007 by an additional 44,000 and in Q2 by 42,000. On a forward-looking basis, about 40,000 new subscribers are expected per quarter, not including those who are switching from analog to digital (in the Q1 conference call, Telular acknowledges that most of the new subscribers were not previous analog subscribers). As more and more consumers opt for the wireless alarm or VOIP service, the number of subscribers to Telular may increase, but a conservative subscriber user base was used to better reflect risk due to the to the likelihood of increased market competition and new technology.

Future Cash Flow Analysis of WRLS
Based on the balance sheet is appears as if the profit margins for the subscription service stand around 50%. According to the investment presentation, customers pay about $50 per year in monitoring costs (Telular Investor Presentation, slide 14). This translates to the company earning $25 per subscriber each year. A corporate tax rate of 30% should reduce income to $17.5 per subscriber each year. To value Telular’s cash flows, the expected flows are discounted to present value with an appropriate discount rate. The current one year LIBOR rate of 5.43%, an assumed market risk premium of 3%, and a beta of two were used. Therefore, the cost of capital for the firm is . The model shown below assumes that there will be 690,000 subscribers in 2008 (the current 220,000 + 80,000 estimate for the rest of the year + 390,000 upgrading from analog to digital) and that subscriber growth will continue to grow by 160,000 users per year until 2013. The present value of future cash flows is calculated as

=$184,373,935/18.24 million shares outstanding

This simplified discount cash flow analysis shows that the stock should be trading at $10.10/share and, based on the current stock price, is currently undervalued.

Current Standing of WRLS
By Q2 of 2007, FCT revenues of $16.3 million have far surpassed the FCP division revenues of $4.6 million, a stark contrast to the total revenues from FCT of $44.6 million and FCP total revenues of $48.5 million in FY 2006. FCT sales are expected to continue to increase as the company seeks to expand its international sales. By Q2, gross profit margins increased to 26% from almost 20% in FY 2006, reflecting the changes at the company as Telguard sales and services are becoming the cash generator for the business. Despite the higher gross margins, Telular was not profitable in recent quarters due to increased operating expenses related to selling the Telguard unit.

The company’s overall operation margins remain low at -8.7% for the past quarter, but have increased from -12.7% in FY 2006. A significant risk is that the company is transitioning from product sales to subscriber revenue for growth. The company might have to sell the Telguard units at a lower price in order to entice the residential market consumers to purchase the unit, which can result in shrinking margins. This may not be detrimental to Telular if it can convert the purchasers of Telguard into long-term subscribers. The FCP division may continue to lose money which may further harm operations as the company loses focus and invests in money losing lines of business.

Conclusion of Telular
Overall, Telular is a Buy because the Telguard subscriber base can provide a recurring cash flow that can be extremely valuable. Based on forecasted future subscription profit, the company appears to be undervalued. The main risk for this company is that a large subscriber base will not materialize; therefore subscriber growth should be carefully monitored as this may affect valuation of Telular.

Full Disclosure: I currently own WRLS and I came to all conclsusions independently.

This report was drafted in the summer of 2007.

*This material is not a recommendation of any particular security, is not based on any particular financial situation or need, and is not intended to replace the advice of a qualified attorney, tax advisor or investment professional.*

Sources Cited:
Yahoo Finance, Telular Corp. Retrieved July 9, 2007.
Telular Corp. 2006 Annual Report. Retrieved July 9, 2007.
Telular Corp. Investor Presentation, May 2007. Retrieved July 8, 2007.
Telular Conference Call. Q1 2007.

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