Drone And Edge AI Headwinds Will Challenge Execution Yet Long Term Potential Will Persist

Catalysts

About Lantronix

Lantronix provides edge AI compute, embedded connectivity and critical infrastructure monitoring solutions across drones, aerospace, defense and enterprise markets.

What are the underlying business or industry changes driving this perspective?

• Although drones are becoming a larger part of defense modernization as unmanned and AI enabled platforms gain more funding focus, Lantronix remains concentrated in Group 1 and 2 short range reconnaissance drones. Any shift in program priorities or slower execution could limit the conversion of expected program volumes into sustained revenue growth and earnings.
• While the move up the stack from compute modules to intelligent imaging platforms and full system workflows can support higher average selling prices and margins, it also raises development complexity and execution risk. This could pressure gross margin and delay the timing of revenue from newer platform oriented offerings.
• Although critical infrastructure monitoring and the Tier 1 mobile network operator rollout are supporting a growing mix of software and services, software and services still account for only about 6% of total revenue. Any slowdown in new deployments or delays in expanding to additional tower applications could temper the intended lift to recurring revenue and margin stability.
• While brownfield upgrades that add AI to millions of existing cameras through products like SmartEdge.ai and SmartSwitch.ai expand the addressable market, customer adoption cycles for retrofits can be long and budget constrained. This may limit how quickly this can translate into higher infrastructure related revenue and improved gross margin.
• Although the broader shift away from Chinese drones and increased US defense and public safety interest support demand for domestic suppliers, Lantronix still faces supply chain pressures such as memory pricing and relies on key technology partners. Any component constraints or partner issues could restrict the pace at which rising demand turns into sustained revenue growth and operating leverage.

Assumptions

This narrative explores a more pessimistic perspective on Lantronix compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts. How have these above catalysts been quantified?

• The bearish analysts are assuming Lantronix's revenue will grow by 13.7% annually over the next 3 years.
• The bearish analysts assume that profit margins will increase from -7.9% today to 2.1% in 3 years time.
• The bearish analysts expect earnings to reach $3.6 million (and earnings per share of $0.08) by about February 2029, up from $-9.2 million today. However, there is some disagreement amongst the analysts with the more bullish ones expecting earnings as high as $15.3 million.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 109.2x on those 2029 earnings, up from -24.8x today. This future PE is greater than the current PE for the US Communications industry at 31.5x.
• The bearish analysts expect the number of shares outstanding to grow by 1.82% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 8.26%, as per the Simply Wall St company report.

Risks

What could happen that would invalidate this narrative?

• The drone thesis is heavily tied to U.S. defense and government programs such as the Drone Dominance initiative and broader unmanned systems funding, so any delay in budget releases, program scaling or follow on orders could slow the move from pilots to large production runs and cap revenue from drones, which are expected to be 15% to 20% of total revenue in fiscal 2027, putting overall revenue growth and earnings at risk.
• Lantronix is leaning into higher value system level solutions and platform offerings instead of just modules. This can support higher average selling prices but also raises development complexity, integration risk and support requirements, so execution missteps here could pressure gross margin, limit operating leverage and reduce net income even if top line demand in edge AI remains healthy.
• The push to grow software and services from about 6% of revenue and to build recurring revenue through critical infrastructure monitoring depends on scaling deployments with a Tier 1 mobile network operator and adding new tower applications such as backup power and rectifiers. Slower adoption or customer budget constraints could leave the revenue mix more hardware heavy for longer, which would cap gross margin expansion and keep earnings more volatile.
• Management highlighted industry wide memory pricing and supply pressures and the need to secure components for newer drone and edge AI products. If supply constraints worsen or key parts become more expensive, Lantronix may face higher cost of goods sold or shipment delays, which would weigh on gross margin, revenue timing and near term earnings, especially as larger production orders ramp.
• The edge AI and unmanned systems markets are attracting many domestic suppliers and ecosystem partners, and Lantronix relies on key technology relationships such as Qualcomm and on OEMs like Red Cat, Trillium and other UAV makers. Any loss of design wins, partner shifts to competing platforms or aggressive pricing from rivals could limit Lantronix's share of long term secular growth in drones and intelligent infrastructure, which would pressure revenue, constrain margin expansion and slow earnings growth.

Valuation

How have all the factors above been brought together to estimate a fair value?

• The assumed bearish price target for Lantronix is $7.5, which represents up to two standard deviations below the consensus price target of $8.88. This valuation is based on what can be assumed as the expectations of Lantronix's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
  
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $10.0, and the most bearish reporting a price target of just $7.5.
  
• In order for you to agree with the more bearish analyst cohort, you'd need to believe that by 2029, revenues will be $172.0 million, earnings will come to $3.6 million, and it would be trading on a PE ratio of 109.2x, assuming you use a discount rate of 8.3%.
  
• Given the current share price of $5.82, the analyst price target of $7.5 is 22.4% higher.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.