Wednesday, November 14, 2007

The bull case for longterm share price appreciation

Let me begin by saying that earnings the last 2 years have been bad and going to be bad in 2008 again. Just looking at the earnings estimates for 2008, analysts are expecting losses of $1.02/share. That is a frightening number when compared with the current stock price of $3.3. The street is waiting for the company to be profitable or at least be cash flow positive. Target prices are a fraction of book value. While this may seem reasonable and a reality of the current moment, this ignores the strategic position and assets the company has. For the past few months, I and others have added up liquid assets (cash, investments, and even the PCD) to size up the current situation and assess potential for a liquidity crisis that could negate any potential for a future turnaround. This was necessary because we did not have access to the financials, did not know whether the company was going to be sold/go private, did not know how quickly they would burn through cash, the impending convertible bond situation or the status of the current business itself.

Through the filing of 5 quarters of past results (Q3/Q4 of 2006, and Q1-Q3 of 2007) and update conference calls, I can say that I have never felt as confident about the turnaround as I have now. What turnaround am I talking about here? The share price going to $6, 10, 15, 20 or higher? No, the turnaround will be about discarding none-core assets, reducing bloated expenses and growing core revenues in the sectors and countries with explosive growth. Most of the long shareholders that bought 2 to 3 years ago had this in mind but circumstances and company mismanagement has moved away from this. Now, I can see the beginning of getting back to this situation/goal. Let me highlight some key developments recently:

-Separating the core and none-core business. The acquisition of the PCD division was the beginning of the downturn, moving away from their core goals/competency. It tried to cover up revenue loss from PAS and the company moved away from growth to a low margin company with losses and lost direction. Now, management has decided to realign the business units and separate the PCD division. Most shareholders have been talking about separating and selling the PCD for a long time now. On the last CC, Blackmore is basing target R&D and SG&A ratios to revenue that does not include the PCD. An analyst also asked about operating expenses for the PCD under the cover that the PCD is the largest revenue source for the company. However, this is really to value the PCD for sale in 2008, which even S&P concedes will probably happen.

-Growth drivers. Broadband and IPTV. UT current has 500k live subscribers and 2m system capacity. Current booked revenues are $240m, which only $80m has been recognized. These are not impressive numbers considering trials have been going on for years and the amount of R&D and other expenses they have incurred to acquire/develop the technology. However, the key take away is that commercial deployments have started and UT is the leader in very large markets. They have commercial deployments in Brazil (10,000 subscriber deployment now confirmed with Brazil Telecom), China (over 60% market share and 380k live subscribers-compared with 800k for PCCW-leader in HK, also was awarded sole provider for one province), India, and a new Asian country to be announced. UT is also providing the massive NGN/broadband infrastructure that needs to be built to support IPTV and other related products (65% market share in Korea, replacing old Siemens, Alcatel equipment in the Philippines, where other Asian telecoms are reviewing the deployments). The market is aware of this but is focusing on the “timing” when broadband/IPTV revs are going to hit. With the liquidity issue aside, I am more concern now about market share and start of deployments.

-Other technologies/drivers. Gepon, IP surveillance, FMC, new PAS technologies etc will provide future growth as well. Even with all the losses, the company is able to maintain R&D. There is a difference between a dying company burning cash and a company “choosing” to maintain R&D because they see the bookings and potential markets. This really is about the longer term growth and profitability so I agree with the steps taken now.

-China market. Almost every other company tries to get in China and increase revenue there. For the last 3 years, China revs have been declining and they are reducing head count and expenses. Since June, Lu has spent time there and have hired new management, improved controls/customer relationship and looking into the broadband market aside from iptv/pas. Aligning the PAS business back into core was smart to do. They cannot lose the relationship built up over the years. I am happy to see the company is refocused in China.

-Liquidity. This is a concern due to the current cash burn and CB due March 2008. The company was fortunate to have Gemdale and Infinera increased. Barton mentioned they have started monetizing Gemdale last week. They are able to transfer significant sums of money from China and have a target to reduce OPEX to $115-120m. At end of Q4, they still should have over $200m net cash and if they are able to extend the CB, would have half a billion to see this turnaround through.

The timing of the turnaround has always been questionable but this depends on the definition as well. For me, the turnaround has started and will be symbolized by the sale of the PCD division. Blackmore has targeted end of 2008/early 2009 to realize his target ratios. Previous discussions of profitability were not believable because there was no plan. Now, there are cost cuts and bookings to guide management.

The management has laid down a reasonable timeframe and benchmarks. Previously, I had lost hoped and wanted a sale. We are way past that point at this stage and prepared to wait it out. I think the strategy has a very good chance of working and the share price will appreciate significantly.

1 comment:

tim_94305 said...

Here is a yahoo posting by Nawar that back-calculates UTs projected core revenues IF opex ratios that Blackmore recently presented are achieved.

I replied to Nawar regarding my thoughts on why the current shareprice is at and its NOT because the market is inefficient in this case. Its because they have serious issues to overcome.