Friday, January 18, 2008

The bear case against UTStarcom

It is always constructive to evaluate the negative as well as the positive issues for companies that you owns shares in or those you are thinking of buying. Here are the negatives for UTStarcom (for those with a weak heart and don't want to read anything negative about the company, you can and are advised strongly to skip this post now).

Weak operational results - Did I just say weak? Maybe collapse is a better word for this. All data are from the recent Q3 2007 filings (no need to go very far to dig up this kind of performance). For the 3rd quarter, broadband infra revenues declined from $50.7m to 42m yoy. Wireless infra (PAS) declined from 110.3m to 67.7m. In addition, GMs declined significantly. For the gross margins, I will use the latest 9 month comparisson. Broadband infra GMs went down from 18% to 7%. Wireless infra went down from 48 to 36%. Handsets (PAS) declined from 93.1m to 59.2m for the 3 months yoy. GMs moved up slightly but that is a huge drop in PAS handset revenue. The only bright spot was the PCD which had increasing revenues and gross margins but did anyone buy UTStarcom for the PCD business unit and its perpetual low margins and even tougher competition?

IPTV growth - This is the main growth driver for the future and by late 2007, the company had 600k live users. However, they have been developing iptv for years and have spent hundreds of millions over the years. Net revenue recognized so far was a pitiful $80m of the $240m in contracts signed. It takes anywhere from 6 months to 12 months to recognize revenue for any given project. Gross margins are in the 40s but only for the core equipment. Set top boxes have GMs under 20% and comprise the bulk of the per user iptv revenues the company expects. There is also no guarantee that clients will use UT STBs. Deployments in China, UTs biggest potential markets have been slow and projections for the "inflection" point/significant increase in orders have been consistently pushed back year after year.

Expenses - UTs iptv growth could be considered exponential and they are one of the top providers already. However, when compared with the amount of revenue/profits it brings compared to their expenses, the numbers do not currently justify the costs over the years. The company has projected to cut costs from $130m to $115m per quarter. The problem is their gross profits are in the $70-90m range. For a company that has been unprofitable since Q2 2005, facing rapid/steep declines in its PAS cash cow and an upcoming convertible bond due in March, it is seems their bloated cost structure is not their priority over the last 2 years.

Liquidity/Convertible Bond - A $275m convertible bond comes up in March. Its kind of an important issue specially when the entire market cap of the company is $350m and almost a third of the shares have been shorted. They have enough money to pay it off in theory but most of it is in China. Working capital has diminished significantly and expected to decline more with the recent operational performance. The company does expect to have sufficient working capital for the next 12 months. Thats always good to hear. Shareholders are reduced to waiting for them to liquidate precious investments that have luckily gone up. Of course, they need to transfer more cash from China.

Competition - In their largest core market China, they have two of the fastest growing, very well capitalized locally developed competitors in ZTE and Huawei. Those two compete in every core product category in China and abroad. Overseas, they face incumbent or much larger competitors in Ericsson, Cisco, Alcatel-Lucent, Nokia-Siemens, and others.

India and international expansion - This has been a "bright" spot with revenues increasing significantly but at numerous write offs of significant amounts and very low initial margin contracts. From the most recent 9 months, China revenues have declined from $595m to $390m. This should be offset by international revenue outside China, right? Japan, with much higher gross margins, delivered $54.7m, down from $116m in the same 9 month period in 2006. What happened to their relationship with Softbank? Revenue from "Others" declined from $117m to $103m. Of course, these were in 2007 and 2008 has added bookings and contracts to be recognized, but they have been talking about replacing China revenue with overseas revenue since 2004 (and probably much earlier). Most of the lost revenues have so far been made up from the PCD group, which they had to acquire for $165m (plust debt) and then susbsequently miss most margin targets for this business unit. In addition to buying assets, they took on the resale business for certain parts of the world from Pantech Curitel. This is only for 3 years and the company had to write off inventory from this deal.

The cost of the filings - An additional 20000 manhours were spent in performing investigations and refiling the previous 7 years of results. In addition, in order to avoid being in default with the CB, they had to pay an additional $22m just in 2007 to satisfy the bondholders so that UT would not be in default. Let me repeat that number again. $22m! The company would have to sell about $400m from the PCD just to recoup that amount. Thats on top of the regular bond interest of $16m year after year. The company does get 2% on most of their half a billion worth of cash sitting in safe Chinese banks. They have not touched most of these funds for collateral purposes. Thats a good example of the "low" cost of doing business in China. The company per Barton is very proud of the recently filed SEC report displaying all the gory details of the additional CB interest and Nasdaq filings. Its like re-enacting a horror show over and over again. It will send chills up your body when you read those. At every step of the way, we investors thought the company MUST be close to filing. They could not possibly be so incompetent as to pay millions in additional interest, could they?

Strategic Alternative Study - Covered well in my recent posts but what where the chances of an outside entity buying the company with the issues it was facing in late 2006 and 2007. They did get rid of their Chinese CEO and co-founder Ying Wu, which was suppose to take over as CEO just in early 2007. Its always nice to add some additional news like when Apple CEO Steve Jobs says, BTW,....For UT, it was no sale of the company, no detailed explanation, and BTW, Ying Wu is out. All at a time, when all we shareholders wanted was the filings to be done and to get some information on the performance of the company. For a publicly held company, you would think they may share some preliminary information with the public. Over a year of silence went by until the stock had lost 70% in value and 90% in just a few years.

Intangible Assets - In a SEC filing, the company put out a note saying it is essential that key management personnel be retained and that performance would be impacted if they were to leave. Huh?!? BTW, I know that wasn't the intangible assets you were thinking of. Rather than talk about the $2/share and $4 billion 2005 guidance, or the strength of iptv and 3G (and its subsequent writing off the entire WCDMA group), the 2007 and early 2008 cash/Gaap profits forecasted, we can talk about their salary (tied to other $2.5b companies no less but that inclused PCD if you are keeping track), raises, bonuses, and retention bonuses. Lets not.

Future forecasts - A new future CEO in Peter Blackmore was announced in 2007. Wait, wasn't Wu going to be the new CEO as announced in 2006. How about a "constant quarter by quarter improvement" forcasted by then new CFO Fran Barton 2 years ago. Supposedely, they were getting improved accounting systems and supply chain management thingamajigs implemented 2 years ago. I guess they forgot to tell Blackmore they have been working on tightening the controls for a while. Don't want Blackmore to look silly, do we? or to reinvent the wheel (maybe they do). Head count and cost reductions. Been there and done that. Good to see they are still lowering costs and waiting for revs to catch up. There is now a sense of urgency and a committment from Peter Blackmore. That sounds good and new. One thing that is new for sure is the new 52 week lows that we saw continuously flash before our eyes in 2007. If the next few quarters don't go according to the sense of urgency plan, I guess they could always cut more costs, fire somebody (or maybe promote somebody first ala Sophie), announce another strategic study (thats always good for a few bucks on the stock price and this time they will have current filings to make it more credible). Heck, it may be better to just announce more investigations to delay results for another year if results are really going to be bad again.

Is there a siliver lining to all of this? Definitely, read most other posts on this blog. Just wanted to remind longs that with valuations this low comes real drama and excitement with this company. For new/potential longs, just wanted to let you in on the fun. I do recommend buying based on the accumulated knowledge you will gain on what to look for in a good investment (think about that one for a while), and you may even gain significantly if this is the start of a major turnaround. If this is not enough excitement for you, you can always just do what most sensible UT longs have done............Give up. Hell no,........ double down :-)

BTW, this post may not have been fully endorsed by the blog creator or written with the clearest of minds or may have just been a bad dream. Now, back to your regular local programming and count down to the NEXT "earnings" report.

1 comment:

Anonymous said...

yep,....excellent summary, you finally seem to check out reality now!
the only "hope" for longs & honest retail investors is, that fran "fraud" barton , hong "lie" lu and the rest of those crooks like thomas toy(boy) at the end of the day end up in jail and not with another bonus...

with respect