Adesto Technologies IOTS
July 31, 2018 - 12:08pm EST by
2018 2019
Price: 5.50 EPS 0 0
Shares Out. (in M): 28 P/E 0 0
Market Cap (in $M): 154 P/FCF 0 0
Net Debt (in $M): 1 EBIT 0 0
TEV ($): 155 TEV/EBIT 0 0

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Business Description
Adesto is a fabless provider of application-specific, non-volatile memory (NVM) for next-generation Internet-of-Things (IoT) devices such as smart home appliances, wearables, Bluetooth devices, and industrial smart meters. IOTS’s high-margin NVM products are based  on two product technologies: standard floating-gate serial flash and its flagship Conductive Bridging Random Access Memory (CBRAM) technology, with proprietary offerings designed for IoT devices operating in energy-starved environments without sacrificing device performance.
For the pro-forma 12/31/17 period, the combined IOTS entity would have generated $100MM of revenues and $53MM of gross profit.
Transaction Overview & Recent Events
On 6/29/18, IOTS acquired thinly traded nanocap, Echelon Corporation (Nasdaq:ELON) for ~1x revenues, 2x gross profits and ~3xest.FCF. Echelon, adot-com darling (stock peaked at over $1,000 per share) operates two segments;
Embedded components, modules and edge servers that enable OEMs and other 3rd parties to develop industrial IoT devices. Echelon’s products reach a wide variety of  industrial applications, from HVAC systems to elevator controls, transportation, etc. This division is a direct peer to DIGI’ embedded IoT business and grows in the mid-single digits.
In 2014, Echelon acquired Lumewave, a wireless outdoor lighting control systems provider. This division is relatively small (under 20% of revenues) and is money losing. This division is highly likely to either be shuttered or sold post acquisition. This division competes against CREE’s RF LED chip/components division.
Avnet is ~28% of revenues.
On 5/9/18, Adesto acquired S3Semiconductorsfor~$35MMin cash and potential for up to $15MM in earn-outs. S3 is a provider of mixed signal RF application specific integrated circuits (ASICs) serving the industrial IoT and satellite communications end markets.
This segment has high gross margins in excess of 60%;
S3 generated $2.2MM of EBITDA, $13MM of revenues with a $15MM run-rate per  management. This implies a 2.3x EV/Rev multiple.
Financed with ~$35MM of debt and cash on hand. IOTS refinanced their existing  term loan.
S3 is a key partner with ARM.
Investment Thesis
Adesto has consummated two transformative acquisitions over the past three months, transitioning from a niche specialty IoT memory provider into an amalgamation of three high gross margin niche Internet of Things chip businesses covering a wide variety of capabilities and end markets. Importantly, the combined entity exhibits healthy organic growth of 20% or better which when integrated, should lead to significant cash generation driven by operating leverage and it’s 50%+ gross margin profile. Despite this, IOTS stock has declined due to a mix of financing requirements to consummate the ELON deal in conjunction with a gross margin miss for 2Q18E driven by (1) order delays/push-outs for spec mem likely driven by the SLAB/Z-Wave acq (customer of IOTS; and (2) larger than normal order of lower margin standard flash. This created the perfect storm cratering the stock from ~$9 per share to under $6, where it stands today.
IOTS is a “story at a reasonable price” or “SARP” investment at 1.5x pro-forma revenues.  Importantly, Adesto equity should re-rate over the next year as the market gains excitement over the Company’s organic growth profile linked to attractive IoT end markets and the  corresponding earnings generation which accompanies the ramp-up in revenues.
Attractive Valuation:
o IOTS represents an attractive risk-reward at ~1.5x pro-forma revenues and  under 14x FY19E earnings. This is anundemandingvaluation for a company growing organically in excess of 20% per annum.
o IoT transactions have been consummated in excess of 2.5x revenues. For reference, Z-Wave was recently acquired by Silicon Labs for 4.5x revenues.
Assuming 2.5x to 3.0x revenues, IOTS’ intrinsic value is in excess of $10 per share.
o It is very rare in the current environment to find niche semi businesses trading  near 2x revenues with strong organic growth. Hence, it is highly likely IOTS is sold over the next two to three years to a strategic buyer. Note, IOTS has no controlling shareholder and could be a target for activism.
Strong IoT Outlook and Organic Growth Creates Opportunity for “SARP”:
o Adesto is one of the only pure-play “internet of things” assets on the market at a reasonable valuation. Given the end-markets it serves, IOTS has a strong
probability of becoming a “Story Stock at a Reasonable Price”.
o Note IoT devices are expected to continue growing in excess of 20% per annum over the near future.
o Driven by adoption of IoT products and certification for Adestos’ memory lineup, the Company has reached an inflection point as top-line growth has accelerated from LSD in FY15/FY16 to 30% over the past four quarters. Importantly, the Company has transitioned from Adj. EBITDA losses to Adj.
EBITDA profitability.
o IOTS is effectively transitioning into a provider of broad-based IoT chips ranging  from memory, ASICs and modules across a diversified customer base, akin to Broadcom (AVGO) or Silicon Lab (SLAB)
o As operating leverage is demonstrated on-top of continued top-line growth,  IOTS will likely garnish significant investor attention, akin to LITE in 2016 into 2017 on 3D sensing.
High Margin Business Allows for Significant Operating Leverage
o Adesto is a mixture of niche high gross margin IoT businesses, a strategy similar to AVGO or LITE.
o Like VPG, given the 50%+ gross margins, Adesto’s operating model has  significant operating leverage embedded. Per management, every incremental
drops to EBITDA at a 40% incremental margin.
o IOTS is likely low-balling synergies from its ELON acquisition. Recall ELON has  ~$22MM of corporate over-head. Rent alone for its expiring headquarters is ~$1MM per annum, public company costs another $1MM to $2MM while further synergies are likely to be realized as it potentially shutters or sells the money-losing lighting division. All-in, synergies are likely to be closer to $10MM per annum versus $5MM. This is significant considering the ~$16MM FY19E EBITDA
Diversified Customer Base & End Markets
o IOTS products serve a variety of industries and customers (over 2,000) with no significant end user concentration.
o Echelon also has over ~2,000 customers across the industrial space.
o Adesto services a wide variety of industrial, consumer and healthcare end
Why Does This Opportunity Exist?
Micro-Cap and Stock Price: Misperception of already missing the move with current  YTD stock appreciation (now reversed) and micro-cap status with an under $200MM market cap.
Skepticism around Historic Operating Leverage & Profitability: Despite having strong  gross margins north of 50%, Adesto has not achieved significant EBITDA profitability. Starting in 2Q17, IOTS reached Adj. EBITDA profitability for the first time as revenue scale starts to be achieved. Going forward as IOTS continues to grow its top-line, revenue should drop down to EBITDA at ~40% incremental margins.
This was exacerbated by the 2Q pre-release which noted weaker gross margins, driven by a larger order of standard flash (sub 40%, say ~38% GMs) and a push-out in spec memory. Our diligence suggests this is partially attributable to the SLAB acquisition of Z-Wave, which is a customer for certain Data-Flash L memory for it's chipsets. 
Consensus updates estimates for IOTS accretive acquisitions and operating leverage. As IOTS demonstrates operating leverage in FY19, the stock should re-rate in tandem.
Take-out by a strategic such as SGH, Panasonic, etc. Recall, IOTS would likely be  acquired for 2.5x to 3.0x revenues. If IOTS lingers under 2x revs, it'll likely become an activist target.
Continued growth of IoT products. Recall, certain end markets for IOTS such as spec. memory have grown at 20% or greater.
Assuming IOTS generates ~$120MM of revenues and 52% gross margins (below 53% PF) and ~$48MM of OpEx, Adesto should generate ~40c of EPS. Assuming ~20x EPS, IOTS would be valued at ~$8 per share or 30% upside.
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