Tuning in to Sarantel's long term potential

One look at the share price graph reveals it has been a difficult month for Sarantel (LON:SLG), which makes filtering antennas used in GPS devices and mobile phones.

Not that its recent problems have been of its own making – they were the result of technical problems at two of its major customers, which have slowed up sales.

Counterbalancing this was the news of a US$287,500 development order from a major defence contractor.

However the market has chosen, at least in the short term, to concentrate on the negative.

Sarantel’s experience is not an uncommon one. In fact it afflicts hundreds of small and growing companies dealing with larger customers.

It means order flows are lumpy and unpredictable, but it is a problem that recedes as the business grows.

None of this should deter investors from taking a closer look at Sarantel. For this isn’t about what happens next week, or next month. It is about what happens in two or three year’s time.

For Sarantel’s particular technology could - once the market is properly switched on to the notion - be the driving force behind mobile marketing and the commercial application of social networking.

However the handset manufacturers are only just starting to latch onto the potential of this small copper coated, centimeter-high capsule that has been around since the year 2000.

It was the brainchild of the company’s chief technology officer, Dr. Oliver Leisten, who came up the idea of creating a smaller antenna by using ceramic as its core. In order to realize this idea Sarantel has had to develop a precision 3D lithography manufacturing process.

One of the unintended but very significant advantages in using this approach was that Leisten’s invention substantially negates the effect of the human body which absorbs radiation and distorts the signal.

This is particularly helpful in handheld devices such as the walkie-talkie. The Sarantel antenna ensures the GPS used in security encrypted military radios is pin-prick accurate.

The US armed forces have been early adopters and it is an area where Sarantel is starting to gain significant traction.

Other uses of Sarantel’s tiny but powerful antenna include prisoner tracking devices, watches for kids with the wanderlust, mobile phones for elderly and a golf gadget that measures the distance from the hole.

Where it has failed to make any impact whatsoever is in the mainstream handsets, yet it seems to be a component tailor-made for the latest smartphones, which now come with in-built GPS.
Up to now the big manufacturers have relied on inferior technology because it is cheaper than the Sarantel antenna.

However the landscape is changing and the market is starting to catch up with the Sarantel technology. Buyers of the latest HTC or iPhone are increasingly unwilling to accept a gadget where GPS is inaccurate particularly in built-up areas when they are using it to map out bike rides or runs.

And if app-based pedestrian satnavs take off, they will require cutting edge antennas that work in all environments and down to the nearest metre.

But there’s another reason why the Sarantel antenna may be about to come into its own. It is the burgeoning mobile marketing boom to which I alluded earlier.

I’m not talking here about spam texts. No, these are laser-focused promotions that are activated when say you stop to window shop or browse the menu at the local pizzeria. And where you’d be texted the latest money-off voucher or two-for-one offer.

The current GPS technology would struggle and fail miserably with this.  Speaking with Sarantel chief executive David Wither, he senses the mindset of the smartphone makers is changing prompted by a big nudge from the GPS chip specialists, who know the current aerials don’t pass muster.

“The innovations are now appearing that we believe are going to drive people to integrate (our product),” Wither tells Proactive Investors.

“We have been out in front of this wave for a while. The market seems to be catching up, catching on.”

A total of £48 million has been spent developing the Sarantel technology. And a significant portion of that cash has been used to protect the intellectual property.

Although the first patent was filed back in 1994, there is a “thicket” of further patents that protect the IP for another two decades at least.

“We are filing patents now we think will give us another 20 years,” Wither adds.

This year is a pivotal one for the company, which could break-even in the second half of 2011 – all things being equal.

Wither finds it difficult to say when exactly this segue to profitability will happen as Sarantel’s orders, particularly from the military, are “lumpy” and unpredictable.

Last year the company made a £3 million loss on sales of £2.9 million. This time around there will be cost savings of around £500,000 after the company outsourced some of its production, and with a 40 per cent gross margin, a good chunk of any additional sales will drop straight to the bottom line.

In December it raised £1.375 million, which it is hoped will be enough to see the company through to profitability.

However it may need to raise further funds for working capital, and perhaps to make the investment needed to develop a product that might make it into the next generation of smartphones.

We’ll know a little more about the company’s cash requirements when Sarantel releases its interims in the summer.

If he does raise money, Wither wants to do it at a big premium to the current price.

“On a monthly basis we still hope to get the business to consistent break-even in the second half,” Wither says.

“But does that give us enough money to invest for the iPhone 6 of or other products in the consumer arena?  Not really. It is important to get the value of the business up so if we are in the position to go after one of these big opportunities we are not doing it in a way that is punishing to shareholders.”

Based on the current share price the downside would appear to be limited.

It has 800 different customers, though only around 40 of them are actively buying in large quantities.

That said contracts it has are blue-chip and in the case of its contract with the US Navy, the customer is footing the development costs of a new product.

So on this base case the company will be profitable and boasting top-line growth in “low double digits for the foreseeable future”, chief executive Wither says.

The intermediate scenario would see its technology adopted in a mass produced device such as digital cameras. Sarantel already has a contract to provide its antenna to the camera maker Ricoh.

GPS allows the photographer to say where and when at what angle he or she took the picture being downloaded to the laptop.
Its adoption in other digital camera ranges could and would transform the business’ earnings profile – though it might take a couple of years for this to happen.

Of course the jackpot would be the antenna's inclusion in the next generation mobile phones. So what’s the likelihood of this happening?

“We are cautious about setting expectations, but we do think there is in the future the potential for this technology to be integrated in smartphones,” Wither says.

We have been here before with Sarantel. The antenna is a true breakthrough and was first spotted by TomTom and a Taiwanese GPS producer named Mitac.

However the company failed to cope with rampant demand for the product and the two customers went elsewhere. It was major setback for the group, and investors haven’t entirely forgotten the episode.

The company’s chairman is Geoff Shingles, who helped make Imagination Technologies a £1 billion success. Imagination found itself in a predicament similar to Sarantel – namely waiting for the market to catch on and adopt its multimedia chips used in all manner of handheld gadgets.

Wither tells me: “These (mobile phone) guys don’t start talking until they need a new technology and then the talk quickly turns to action.

“Geoff has seen this before and is convinced that Sarantel is in the same place as Imagination was a few years ago. 

“The market caught onto Imagination and now it is a £1 billion company. Geoff thinks we are in the same boat and that is why he stuck with Sarantel.”