We downgrade our recommendation for Novatel Wireless Inc. (NVTL) to underperform following its fourth quarter 2009 financial results, which came significantly below the Zacks Consensus Estimate. Unfavorable product mix has taken a toll on the company’s gross margin. Quarterly gross margin of 26.2% was down 5.4 percentage points from the previous quarter.

The company has given a tepid future financial outlook. Management declared that the first quarter 2010 gross margin will be even lower, around 24%.

Intensifying competition for embedded modules is a concern for Novatel. In addition to its traditional rival Sierra Wireless Inc. (SWIR), the company is facing significant challenges from newly launched products by large manufacturers Incorporatedluding Qualcomm Inc. (QCOM) and L.M. Ericsson (ERIC).

Qualcomm has launched its Gobi chipset that combines broadband modem technology for high-speed 3G networks (both EV-DO and HSPA) with GPS functionality. The Gobi chipset is currently used in more than 50 devices. Huawei Technologies and Foxconn are also likely to follow suit. These developments are expected to lower product pricing and may materially impact the gross margins of Novatel.

Although Novatel has developed a niche for its MiFi mobile intelligent hot spot, we foresee increased competition as large firms such as Qualcomm, ZTE and Huawei Technologies are on the verge of introducing their own version of intelligent mobile hot spots. Novatel’s product sales depend to a large degree on the market dynamics for wireless access to enterprise networks and the Internet and may be impacted by alternative solutions.

We do not find any near-term growth catalyst for Novatel and believe the company to incur loss for full year 2010.

Zacks Investment Research

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