Novatel Wireless downgraded at Jefferies

Jefferies & Co. downgraded its rating on shares of Novatel Wireless Inc. (NVTL) to hold from buy and lowered its price target to $8.50 from $13.50.

Our downgrade is due to: Asia original equipment manufacturers (OEMs) launched LTE modems sooner than expected, mobile hotspot functionality is being integrated into smartphones, weak Q1 guidance by Sierra Wireless Inc. (SWIR) and Smith Micro Software Inc. (SMSI). We now see the risk/reward as balanced, said Peter Misek, an analyst at Jefferies.

In a nutshell Misek was strangely disturbed by what he heard and saw in the results of Sierra Wireless, Novatel's largest pure play competitor, and in Smith Micro's lowered forecast.

Rather than having a multi-quarter low competition window during the early stages of 4G, Asia OEMs launched LTE modems at the same time or even before Novatel. Misek has expected Novatel to benefit from a bias among OEMs and carriers to utilize more experienced players. Misek therefore believed Novatel could gain share from Asia manufacturers in the early stages of this transition.

In previous generations carriers have encountered difficulties in transitioning from one generation to another, and therefore look for system-like expertise to assist them in deploying new solutions and ensuring connectivity issues are resolved quickly. But a combination of faster development from the Asia OEMs and greater carrier price sensitivity has shorted the runway for Novatel.

Misek said mobile hotspot functionality is being integrated into smartphones, meaning that the MiFi addressable market will be less than Misek had initially thought.

Sierra Wireless, a key competitor of Novatel, reported results that missed expectations on both the top and bottom line, while offering guidance below Street expectations. Additionally Smith Micro, in Misek's view a solid read into Verizon's (VZ) USB modem business, warned for first quarter. Misek believes both foreshadow issues that could be seen by Novatel when it reports on Feb 24.

We believe Novatel should see some tailwind from some key drivers: Enfora customers are likely to feel more comfortable in the combined company and importantly potential new customers are now likely to view them as a serious contender. We continue to see opportunity in the 3G to 4G transition on the connectivity side. Sierra Wireless noted that Novatel is gaining share at Sprint, and Novatel should benefit from channel fill for its new LTE MiFi at Verizon, said Misek.

Enfora is a machine-to-machine (M2M) player. The non-PC connectivity market is grouped broadly under the M2M umbrella, which effectively is about making more devices and services connected and therefore enabled.

Misek finds the M2M market to be a bit baffling as it is shaping up to be shared primarily between Sierra Wireless, Gemalto, and Novatel, and surprisingly he has not picked up any indications yet of larger firms entering this fast-growing market.

Novatel's module business is highly cyclical while the M2M sector offers synergies and a secular growth story. After Sierra Wireless' acquisition of Wavecom and Novatel's failed acquisition of Centurion, Novatel finally succeeds in entering M2M with Enfora.

Misek said the deal closed at the beginning of December. Novatel paid $64.5 million in cash plus a possible $6 million earnout for Enfora (including debt). Enfora had trailing 12 months revenue of $61.3 million with about 36 percent gross margin. Based in Texas, Enfora has 125 employees (half engineers and techs; 1/3 sales and operations).

The brokerage widened its 2010 calendar loss per share estimate for Novatel Wireless to $30.00 from $0.33, while increasing its revenue estimate to $338.4 million from $333.3 million. The brokerage lowered its 2011 EPS estimate to $0.41 from $0.75, while raising its revenue estimate to $513.9 million from $498.7 million.

Our new estimates include the Enfora acquisition, but Street estimates do not appear to include it as management has not given forward guidance with it yet. We include a month of Enfora in Q4 and $70 million in revenues in 2011. We cut our non-Enfora estimates due to lower than expected sell-through of MiFis at Verizon and to reflect caution stemming from less carrier promotional activity outside of Verizon, said Misek.

Novatel stock closed Tuesday's regular trading session up 1.37 percent at $7.39 on the NASDAQ stock market.