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The Business

Telit Communications (TCM) is the third-largest global developer and manufacturer of cellular and short-range radio communication modules for machine to machine (M2M) applications that enable machines, devices and vehicles to communicate via wireless networks. Its main areas of expertise include automated meter reading, transportation, security and consumer/professional.

Founded in 1986 as an engineering company providing research and development services to multinational telecoms, Telit eventually emerged as one of the leading names in innovative cellular technology. In 1997, the company began manufacturing and marketing products under the Telit brand. Having grasped an early understanding of the potential of M2M applications, the company launched its first M2M module called Datablock in 1998. Allowing real-time monitoring and control, minimising or dispensing with human intervention, M2M is gaining significant market traction as it addresses the ever-increasing demands of businesses and consumers in terms of speed, savings, safety, environmental protection, localisation, remote control and accuracy.

Telit’s product families are tailored to different levels of integration and volumes according to application size and production scale. All modules of one family have the same size and shape, the same connectors or Ball Grid Array (BGA) and the same software interface so that that they can be integrated and exchanged easily into existing customer designs with only minimal adaptation. As a result, customers benefit from modules that can be used for years in their applications, avoid additional development outlay and thus protect their previous development investments. This backwards compatibility also acts as a strong barrier to entry.

Current Trading

Telit posted a 61% jump in revenues to $59.6 million for the six months to 30th June 2010, helping it to swing into a net profit of $1.4 million versus a loss of $2.6 million in the first half of 2009. This performance was better than guidance given at the end of June and much higher than growth rates in the wider sector, prompting several upgrades from brokers. Significantly, the firm also continues to secure a design win rate higher than its market share (c.25% of all new designs versus a 12.4% market share). This means growth rates should exceed those of the wider market for the foreseeable future given that it typically takes a couple of years for design wins to translate into new revenue streams.

Telit’s gross margins fell slightly year-on-year in the first half, from 45.8% to 42.2%. However, this was largely a result of customers taking larger orders, although there was some reduction in average selling prices due to a general reduction in component pricing, the emergence of lower function modules and greater efficiency. The recent relocation of the firm’s manufacturing facilities to China should help mitigate any further downward pressure on margins, and the firm expects them to stabilise just above 40%. The China move has also increased capacity and should help the firm continue to capture greater market share in the future.

Telit is diversified both geographically and by industry sector. EMEA (Europe, the Middle East and Africa) revenues jumped 61.7% to $36.7 million while revenues in the Americas soared 93.8% to $12.6 million. APAC (Asia-Pacific) revenue growth was less remarkable but by no means prosaic at +33.7% to $10.3 million. Growth prospects for all territories remain good as a number of new applications come through. No one customer accounts for more than 4.3% of sales and Telit increased the number of direct customers during the period to more than 60% of total sales, thus decreasing its dependency on the indirect distribution channels.

In the third quarter, overall global demand remained strong, with revenues for the 9 months to 30th September reaching approximately $98 million, an increase of over 60% on the same period a year earlier.

Opportunities and Threats

According to industry specialists Beecham Research, M2M network connections will reach 75.1 million by 2014, with the number of units to be shipped achieving a CAGR (compound annual growth rate) of 29.2% during 2009 to 2014. Beecham Research also projects a continuing decline in the average sales price (ASP) of the M2M products with a CAGR of -9.6% during 2009 to 2014 as the market matures. However, due to the greater CAGR in the number of units shipped, the total value will increase with a CAGR of 16.7% over this period, from an estimated $700 million in 2009 to an estimated $1,518 million in 2014. This year Telit expects its market share to reach 16%, excluding the impact of any potential acquisitions. By 2015 it aims to achieve a market share of 26%.

On the face of it, falling average selling prices may not seem good for a company, but the reduction in price is making M2M technology suitable for an ever-growing range of applications, and in doing so is driving the growth of the industry. The end of the global recession has led to a resumption of investment in both industry and the government sector. Mobile network operators in particular are aggressively promoting M2M, and Telit has signed non-exclusive partnership agreements with both Orange France and Deutsche Telecom this year. Investors should be aware that in order to further capitalise on this growing market the company plans to undertake acquisitions which of course carry with them execution risk.

Evaluation

The opportunities to expand the M2M market look impressive, as technology is working its way ever further into new facets of our lives. As a growth business, we value Telit on a PEG (Price Earnings/Growth) basis. Earnings growth of 114% is anticipated for the year to December 2011, while the shares trade on a forward price earnings multiple of 7.8. This implies that the shares trade on a PEG of under 0.09 for 2011, which looks very attractive considering that anything below 1 is generally considered to be good value. With growth expected to exceed the market rate (16.7%) during the foreseeable future, the PEG rating is likely to remain low well beyond 2011. BUY

Key Data
Epic: TCM
Market: AIM
Spread: 75p-78p