Arlo’s buzzing again
Arlo Technologies is a market leader in smart connected home devices for the purpose of home security and video protection. The company offers products ranging from outdoor and indoor cameras, security lights, and doorbells that connect seamlessly to users mobile devices through the Arlo app. Across the product portfolio, users can connect and watch live video feeds and sound recordings in the protection of one’s home. Over the past few years, the smart home devices market has exploded as IoT technology continues to advance and new products enter the market. Arlo is currently a leader in the industry, competing with systems such as Ring, an Amazon company. According to IDC Research, the connected home device market is expected to grow at a CAGR of 16.9% from 2019 to 2023 with 1.6 billion devices expected to be delivered in 2023. According to the firm, Arlo currently holds approximately 40% market share in the industry. Arlo Technologies was spun out by Netgear in 2018, and still maintain majority control in the company after their IPO in August of 2018. The company first traded at a price of $13.40 but is now trading at only $3.16.
What Went Wrong
After their IPO in 2018, Arlo’s stock has struggled significantly as a result of operational issues at the firm. As opposed to many stocks which were affected by the broad market selloff in Q4 of 2018, underlying business issues hampered the firm. The company announced the launch of their new flagship product the Arlo Ultra ahead of the holiday season, however in December announced they were suspending the launch due to a battery issue that was discovered. This caused the firm to materially drop Q4 earnings guidance and sent the stock plummeting. To further compound the problems, the company reported increased on hand and channel inventory, which forced the company to drop revenue and gross margin estimates as they sold older models before introducing the new generation Arlo Products. As a result, the company has to significantly reduce 2019 estimates, only guiding $400 Million in revenue compared to $472 Million in 2018.
The company has been forced to work through inventory levels but based on the Q2 earnings call, CEO Matthew McRae, these problems have been worked through and inventory channels are now finally ready to begin delivering the new Arlo Ultra. The company was able to work through the hardware issue with the battery and in Q2 the company has the first full quarter of deliveries. The new Ultra is the company’s state of the art product offering with key differentiation from competitors. The new product offers 4k streaming and recording, dynamic range, an integrated spotlight that can be activated via the operator and a beamforming microphone. The new product was awarded the Editor’s Choice award by PC Magazine which said, “If you are looking for the best wireless outdoor security money can buy, the Arlo Ultra is your best bet and our Editor’s Choice.” The security of ones home is incredibly important in maintain piece of mind, and the Arlo appears to be the best product to help p people achieve this goal. The Arlo Ultra is a premium product for the company as they sell a three camera set for $799, compared to $649.99 for the previous generation of camera, the Arlo Pro 3. Early sales figure for the product show that demand is high for the product even at an elevated price point for the company, which should lay the ground for the company offering other premium products at higher ASP’s then previous generations. Additionally, in the Q2 earnings call, the company preannounced the launch of a new core camera product that should be available for the 2019 holiday season. The new camera will incorporate 2k video with many of the new technologies incorporated in the Ultra. The new camera is expected to be priced much lower than their previous products in an effort to drive appeal to a broader market of customers. Also, at ISC West the company announced they would soon be selling a video doorbell system which will better allow them to compete with companies such as Ring. The new video doorbell will be fully integrated into the Arlo Smart platform and customers will be given three free months of the Arlo Smart subscription. Furthermore, the company has begun selling direct to consumer with an e-commerce store on Arlo.com. I believe that this is a great decision because the company will be less reliant on their current sales channels and will allow the company to better interact with customers and learn their preferences as well as developing new product bundles.
Although the company has struggled operationally in terms of inventory since their IPO, one aspect of the company that I believe is not getting enough attention is their inclusion of Arlo Smart. The Smart platform is AI software that is capable of detecting people, animals, and vehicles. Additionally, with the Arlo app customers can integrate with Siri and receive Lock screen notifications if the camera detects activity. The company offers three levels of service, with the basic package charging $2.99/ month and the premium service for $14.99/month. The company has been successful in giving new customers typically a three month free subscription to the platform with the hope they convert to paying a monthly fee at the conclusion of the trial. In the earnings call, the company announced a 54% YoY increase in their registered user base, with an increase from 2.2 million users to 3.4 million in Q2’19. In this same time period, the number of paying customers increased 83% YoY to 187,000 users in Q2. This amounted to $11.2 Million in services revenue, which represented a 23% YoY revenue growth. This growing subscriber base adds recurring revenue for the firm, which should lead to greater predictability in sales and decreases the burden on channel sales. CEO Matthew McRae stated that the long term objective of the firm is to increase services revenue to 30% of sales, with Q2 represent only 13.3% of sales.
Currently trading at merely $3.19, the spin off of Arlo has been seen as failure as operational issues that could’ve been prevented struck the stock. It is clear that in the coming quarters Arlo’s management will have to rebuild investor confidence in the management of the firm as well as managing their cash position. However, I do believe that with such a large market share of a booming new industry, with the success of the Ultra and new product offerings, the upside on this stock could be massive. I believe that two more quarters of operational and financial improvements will give investors the confidence to start investing again.