Sunday, March 30, 2008

IPTV (cable), NGN, Strategic Study, and Current Share Price

Why doesn’t UT cut expenses significantly more? Why is Blackmore resisting the temptation to cut quicker and get to profitability? Why are they spending most of their R&D in IPTV and NGN? Why is Tim negative in one post and more positive/downright bullish on another (like this one)? Why do I have a $10 year-end target when the stock started the year at $2.75 and why do I and other longs think it will go much higher in the future when it seems so bleak right now?

Let me go back to 2006 again when the company decided to go into a strategic alternative study and was considering to sell itself. Director Thomas Toy mentioned that the board thought the company ($6-7 in early 2006) was undervalued and that PAS decline was a concern and that was why they decided to seek strategic alternatives. I am still confused about the entire strategic alternative study. What valuation where they looking for and did they really believe they could get a good offer then? In late 2006, they were not filing financials and had an ongoing options investigation and nine material weaknesses. They were about to lose $1/share for the year AND instead of being profitable in 2007 as guided (a year plus before that), they were going to lose almost $200m. The convertible bond was not resolved. There were no Gemdale or Infinera stock gains and obviously no IPTV/NGN wins like they do now. According to Toy, they also saw signs of the sub-prime mess that may make any deals hard to close. That was also the time they were writing down $32 million in India and PCD had not improved as it has now. With that situation, why did they feel that $6-7 was undervalued and how much more can they expect to receive? Now, if they felt the situation was really that bad then and had to sell, then why didn’t they sell even if it was a less than an ideal offer or even sell separate parts and get what they can. Why would they then continue spending and ending up losing $200m in 2007? Anyway, this post will show why maybe the management is much more confident than the street is and what the future is in store for UT shareholders. Maybe the problem is a lack of communication or maybe there is just no one listening anymore.

The major hope for UT has always been IPTV with telecom carriers. There were always timing issues because of broadband penetration, regulatory, content and other issues. Slowly but surely, we have seen tangible expansion in China (up to 500k UT subscribers), multiple (3) wins in India (update: http://www.telecomtiger.com/fullstory.aspx?storyid=1148&passfrom=vasstory ), Brazil, and Sri-Lanka. The other potential customer segment in IPTV for UT is cable. We saw the Taiwan win and now are hearing about Hong Kong. Those wins show that UT has a system capable of working for cable companies and can take advantage of this major market. In Korea for example, telcos are waiting for an enforcement ordnance that will allow them to broadcast TV services. Currently, Korean Telecom (KT) has 150k iptv subscribers, Hanaro Telecom has 800k+ subscribers, and LG Dacom has over 200k subscribers. These are currently VOD services only. But these numbers pale in comparison to the 14m on the cable TV platform. This is true in most cases where cable dwarfs iptv from telcos.

From BWS financial last March 20 discussing Sigma designs, “There was news overnight from Taiwanese cable company Vastar Cable intending to begin trials of a HD IPTV service, Vee TV. The demand for top quality high definition service would translate in Sigma Designs (SIGM- Hold Rating) having an edge in receiving this contract. The significance of the news is not who the customer, but the kind of customer Vastar is. Vastar would be the second cable company in Taiwan who has elected to go with an IPTV platform. The first was Markwell Industrial, which chose SIGM. We believe cable companies on a worldwide basis would slowly start to transition to an IPTV platform. We have stated before how Comcast (CMCSA- No Rating) could begin trials in early 2009. The inclusion of cable companies into the IPTV market would create a market opportunity several times larger than telecom carriers alone. Investors should not underestimate the growth of IPTV. The technology remains in its infancy..”

Blackmore added on the last earnings call..” And interestingly Markwell is also our first win with a cable TV operator and we see additional opportunities with that class of carrier.”

While IPTV grabs the headlines, UTs NGN is making tremendous progress. From the last earnings call, Blackmore mentions, “Focusing on our NGN solution, this is designed to support the growing number of advanced voice and data services as we see tremendous growth in Internet traffic and the end of life of traditional TDM switches. We’ve designed our mSwitch to allow the provision of next generation services but also significantly reducing operating expenses of current products. mSwitch supports multiple call types over all access technologies and currently supports over 60 million NGN customers globally. While PLDT is our largest network transformation project to date, our success there is winning us new customers worldwide. For example, last year a major European carrier, Tiscali in Italy asked us to supply them with our MSAN equipment. And just prior to year end, the carrier asked us to replace their entire TDM switching network with our softswitch. This is obviously a very key strategic decision for Tiscali and a very strategic win for us. We are currently implementing this project with them. In quarter four, we also won our first NGN softswitch in Taiwan. Other recent notable contracts include Brasil Telecom, where our softswitch is supporting applications for fixed mobile convergence and IPTV, with TOT in Thailand, and also recently Nextel in Argentina. It is clear that this technology is gaining momentum and we believe we have the best performing softswitch on the market.”

From the latest IPTV news magazine (http://cde.cerosmedia.com/1L47cbd2e382f89012.cde ), FastWeb of Italy is spending 2 Billion Euros over the next 4 years to complete its NGN to deliver voice, data, and video over IP. We don’t know the size of the contract win with Tiscali (smaller than FastWeb and Telecom Italia) but the multiple wins (Philippines, Italy, Taiwan, Brasil, Thailand, and Argentina) does show significant activity in a very short time frame.

Blackmore adds, “Our view is that these two product areas, NGN and IPTV are at the beginning of their life cycles and bookings can ramp fast. We are very pleased with the momentum they are gaining in their respective markets and believe the revenue for each of these product lines can grow in excess of 80% in 2008.”

There was also the hiring of former Alcatel-Lucent executive Diego Martinez. "Based in UTStarcom's regional headquarters in Sunrise, Florida, Martinez will lead the company's sales efforts in Central America, Latin America (CALA) and North America while overseeing an extensive team of sales, engineering and support professionals in more than 30 countries."

Wait a minute. Is this a company that is going BK or have liquidity problems? I see Krispy Kreme closing up some shops and Borders having certain liquidity problems but UT....unless it is a misprint, they just hired a person from Alcatel-Lucent to oversee professionals in 30 countries!

With all the activity in iptv (telcoms and cable providers) and NGN, improvements in PCD/broadband revs/margins, all the financials filed, the accounting system about to be fixed, material weaknesses down to 3, gains in Gemdale/Infinera appeared and actually booked, CB paid off in full, expenses to be further cut, profitability at the end of the year, isn’t it in much better shape than in 2006 when the price traded from $6-7 (even before any ramp up to a possible sale $8-11 high in Oct 2006)?

The lack of communication or maybe no one is listening is also a problem. During our meeting with them, they mentioned going on investment road shows to tell their side of the story. The markets seem very large and they have plenty of strategic wins to showcase their products. It is apparent the street is discounting the company’s previous mis-steps, don’t think management can execute and expenses are still way too high that any positive developments (contract wins) are not signficant at this stage. Shareholders are giving up and the stock continues to languish. The strategic study back in 2006 was really questionable at best. With the current positives, doesn’t management/board think the share price is so much more undervalued than it was then? That’s why I’m both more frustrated and more optimistic at the same time. Lets hope for better communication from management and that they get out and talk about what THEY are seeing in the markets and the major opportunities (size) going forward.

Just some thoughts I had to post before going to bed......good night or is it morning already?

Saturday, March 29, 2008

"Large Startup" and Chuck E Cheese

During the Q3 earnings CC, Peter Blackmore made the following statement, “In some ways, you have to think of UTStarcom today as a large startup. Our previous technologies such as PAS have declining revenues, but we do have many strong technologies to take their place but they are early in their lifecycle and in customer acceptance.”

Those two simple words “large startup” brings amazement, frustration, anguish, hope, reason (explanation), expectations, clarity, confusion, potential, and many other descriptions to UTStarcom’s shareholders and their impressions of the past and current situation. How many startups can compete against General Motors, Microsoft, Google, Altria, General Electric and other leaders in various fields? But, how many would even have the resources or the sensibility to even attempt? Yet, here is UTStarcom competing against the Alcatel Lucents, Siemens, Ericsson, ZTE, Huawei, Nortel and others with their own end-to-end iptv system (no less) and full suite of NGN/broadband, and wireless products. Not only do they compete in those areas but UT even has a handset division! For the most part, it even manufactures its own products and is not “fab-less” like a Rambus or other purely design companies. If you take out PCD and PAS, the company’s revenues for 2008 would be less than $500m. That compares to Alcatel Lucent’s $26b for example. The incredible thing is that UT is actually technologically ahead in some areas and is winning contracts. But what is the cost? The company has used their initial seed money from the ipo/stock sales (in an old article, Lu was even proud NOT to use the initial cash horde because the business was funding itself) and significant PAS profits (and now PCD profits) to build up their arsenal and compete up to now. Huawei and ZTE have done it but does UT have a sustainable competitive advantage to be an all things to all customers? The result of this is a sub $3 share price and shareholders bearing all the downside to get to this stage. Normally, when a company is a startup and goes for an ipo, it will already have become profitable (this was different from before but now most ipos have to be profitable). It would have identified its target markets and have gotten the cost base right. It would have significant cash resources relative to its working capital requirements. It would have high margins and growth rates that would justify an ipo and shareholder enthusiasm.

After 14 or maybe 16 consecutive unprofitable quarters, UT may breakeven and turn slightly profitable. It is debatable whether they would have gotten the cost base right even then. PCD and PAS would still be subsidizing the other core businesses. It IS a significant accomplishment to get to breakeven/profitability under the circumstances but it would not justify the billions in lost shareholder value. Even if it gets there, is there a future for this company 5 years down the line? How many companies survive that long without durable/competitive advantages? The board/management decided in 2006 that it was time to look for an exit strategy and then reversed course and “re-started” again when it could not get a reasonable exit plan. What value does the board think this company can get to? The confusion and suffering of shareholders are not like any startup and I hope Peter and the “newer” managers understand the shareholder’s pain and confusion.

In the group’s quest to protect and unlock shareholder value, there are a LOT of ideas being discussed and have been discussed over the years from asset sales, expense reduction, focusing on core expertise/markets. I think most shareholders know the keys to higher valuations such as higher GMs, profitability, and growth in product areas/markets. UTStarcom definitely has value but does it have the ingredients for attaining significantly higher value to even come close to justifiying the last few years of investments? If not, does it have leadership that will have a reasonable exit strategy? (Toy did mention the company felt that $7 was undervalued back in 2006 and decided to go for a strategic study). Do they have plans to get it back to $10, 15, 20, or 25? Ridiculous to think of a price you say? If you don’t have a goal, you will NOT get there. One of the proposals I discussed back in June 2007 and others have probably discussed earlier was spinning off the iptv/ngn/broadband division.

http://messages.finance.yahoo.com/Business_%26_Finance/Investments/Stocks_%28A_to_Z%29/Stocks_U/threadview?bn=27187&tid=135521&mid=135521

http://messages.finance.yahoo.com/Stocks_%28A_to_Z%29/Stocks_U/threadview?m=tm&bn=27187&tid=139152&mid=139152&tof=-1&rt=2&frt=2&off=1

It is funny to read previous posts and realize how off some of the numbers were (that’s another problem when we didn’t have the financials).

There has been a lot of news regarding Motorola selling and now spinning off their handset division. The problem with selling/spinning off that division is if anybody actually wants it. What are prospects for revenue growth there? That business unit lost $1.2 billion and how much more money do they have to inject to get it to profitability. The unit’s market share is also in decline. Is it feasible to let go off the brand name? Anyway, lots of problems when spinning off the “bad” part of the company.

At a certain point, UT’s iptv/ngn have to stand on its own. It cannot be done now because the revenues are nowhere close to matching the expenses and the equity markets are not good. The PCD (resale and or total) could be sold. PAS is in decline but can maintain profitability. The broadband group has lower margins and lower growth than iptv/ngn. If the iptv/ngn can be spun off in the future, it would give shareholders a vehicle that could appreciate and recoup some of the losses from the previous years. The remaining businesses can maintain profitability but it will be separate from the iptv/ngn pure-play that can make it more attractive for a future sale as well. It is funny to read other shareholders complain about the performance of other companies and read how they can unlock value. UT, compared to Motorola or other companies, has much more value that can be unlocked. It definitely has the frustrated shareholders (whats left anyway). Getting to profitability is an important step (and after 14-16 quarters…) but hardly an impressive accomplishment that shareholders will praise (unless you bought at $2-3) after all the promises/hope of the last few years. What matters most is shareholder value and the stock price that people can exit at. That is the only metric that counts and for those that have sold at massive losses already, the management/board has already failed them. So, in the end, call it a large startup or a large failure or a large turnaround candidate, it comes down to good leadership, strategy and execution that will determine the shareprice. Shareholders are fed up of excuses for bad results.

On a side note, I see some posters giving up on the stock (understandable) and some have given up on the trust for businesses generating wealth for shareholders in general. For me, very few businesses will fail but most companies that have good products/management can turn it around and the US markets will roar back again. I personally will go to Chuck E Cheese with my family/two year old and spend some money. Have a good weekend everyone!

Sunday, March 23, 2008

Recap of Exploratory group meeting with management/BOD (3)

PAS - Management indicated there was an increase in PAS handset demand this quarter but this is just a blip. As I mentioned in another section, most of the R&D is in iptv/ngn and very little in PAS. PAS is still very profitable and Lu had mentioned in a previous cc that they will be able to maintain PAS profitability. As PAS declines, SG&A associated with PAS should decline as well. During the last CC, they had mentioned the new sales model was working well and margins would be maintained (and actually improve slightly) for 2008. A few months ago, I checked the capex spending of CT/CN and PAS was now down to about 5% for 2008 so this is very low on their priority list. The flip side is they should be increasing their spending on IPTV. During the November shareholder meeting, management had put up a chart on PAS bookings and revenues expected for 2008 and it was on a steady decline. This is still what they expect and Barton mentioned he was conservative on his PAS revenue model for 2009.

Softbank/Japan - Since the Japan Telecom contract that was booked in 2005, little or no news has come out of Japan. Revenues from Japan has dropped to $70m in 2007 from $137m and $479m in 2006 and 2005 respectively. Softbank's purchase of Vodaphone's wireless division has refocused their strategy. Coupled with the iptv regulations, this has hurt UT in Japan. I asked management if 2007 rev was the bottom and how their Japan book to bill looked. Management mentioned that book to bill was above 1 (although it was not a quick answer so maybe they were not very sure). The encouraging thing was that the older equipment now has to be replaced so new contracts are up coming. Management also mentioned that the relationship with Softbank is very good and doesn't prevent them from getting new customers. However, it is just difficult to do so because of long term relationships that already exist with other potential customers and their vendors. They did indicate they were looking into a second customer to smooth out the revenue stream in Japan (again, nothing really concrete).

OEMs/tie ups - Nothing new to report.

Building in China/Sale of Gemdale/Infinera - Management mentioned that China regulations are consistently changing and they are just learning what they can and cannot do. I have reported in the blog previously what Chesha mentioned regarding subleasing some extra space and the special hitech tax status that prevents them from selling the building. Mortgaging the building is also possible but I think they are more focused on leasing at this stage. There is no question that the building is very valuable and even at the last appraisal was worth $180m (thats just for the Hangzhou building). The sale of Gemdale holdings came up in the discussion as well and Barton mentioned they sold this as fast as they could. They sold about 10% in November, about 50% in December and the remaining 40% in January (approximately). I didn't go into the sale of infinera but Chesha had mentioned they sold that as fast as they could as well. I'm a bit confused about the infinera because they only got a little over $11/share. During the first day after the lockout period, they could have sold this on Dec 20, 4 million shares traded above $20 (Infinera trades less than a million shares before that) so there were people unloading already. The stock declined steadily but slowly for the next few weeks until hitting $10 and even $9. I'm not a great trader but it was just very disappointing to only get $11/share (close to the ipo price) when I thought they could get closer to $20. They had over 700k shares of Infinera so that was about $6m more that they may have gotten.
Just a general comment. I do not know all the details obviously regarding the building, gemdale/infinera sales, CB interest payments/additional payments (no call option to pay it off so they had to pay the special interest rates and wait until March). The company says they did the best that they could under the circumstances and certain regulations in China were not known or changing or just coming in but it seems "bad luck" or "bad results" consistently surround the company. They also mentioned they hire the top accounting firms, the top planning firms, etc but the end result is all-time share low prices. I hope our luck changes :-)

Strategy in US/cable companies - I've touched upon this in other sections but basically they are not focusing on the US now and it takes time for trials/qualifications. For some reason, we didn't discuss the cable companies but I believe this is gaining steam with Markwell and other cable companies are looking into iptv (not necessarily UT systems however). Check the sigma designs board for a ton of iptv news, some applicable to UT and their part of the woods.

Writedowns - There was nothing to report (good)

Wimax - They won a $600m 2-year contract with BSNL in India !!!!!.....oops just kidding (getting close to April fools day). They did say they won one in Taiwan. (maybe I was just dreaming about that one too).

Profitability - There was a LOT of discussion on expenses because it ties into profitability. Based on the meeting, somehow I feel they are more confident about getting to profitability in Q4 2008. Now, Q1 2009 may be back to losses due to seasonality but overall, I think they were fairly comfortable with Q4 2008 and overall 2009 profitability (after being questioned on expenses, different business units, cost cutting everywhere, etc for 3 hours, they seemed to hold their ground). ALL previous guidance by Barton for profitability has been way off but his recent quarterly estimates (not for profitability of course) turned out to be very conservative so under all the roundabout information and hunches and psycho-analysis and checking the magic 8-ball, it does seem they WILL get to profitability by Q4 2008.

There are probably things that I missed (I didn't take notes down) and would add an addendum if other shareholders that were there point out something. But thats basically, the various things we discussed and got responses for. I once again would like to thank Chesha, Fran, Peter, and Thomas Toy for accomodating the group for 3 hours. I hope the information presented helps out all shareholders out there. Obviously, management cannot release a PR and write like I can but again some of the info I put are my own opinions and not FACT.

Summary - A lot of people had been waiting for the recap post and were asking for my first impressions. As you can see with the amount of information (some positive/some negative), it would not have been good to jump in and post right away. After the meeting, I was drained and did not feel particulary upbeat. Maybe it was the all-time low stock price. Maybe it was rehashing all the past mis-steps and hearing the reasons for some of the mis-steps. Maybe it was the helpless feeling of hoping that this time they CAN turn it around. The meeting was no doubt productive and the stock looks incredibly cheap here (as it has for a while now). I will let people just read the recap and decide for themselves. I personally will keep my shares for a long time. Here is something I posted earlier today which sums up my optimistic view on why it can turn around now.

EVERY move costs time, effort, money, and management focus. Thats why it is essential to FOCUS on the turnaround and not be wishy washy. Identify the key CORE (higher margin/growth opportunities) and monetize the rest. While we are not seeing it in the stock price, there has been significant milestones reached since Peter has arrived. Obviously, it is not one person but that one person can bring the necessary change that others can rally behind and then everyone has a purpose and unified goal. With that, great things can happen.

UTs potential IPTV growth in China - Historical PAS growth

Before I finish posting the recap on the meeting, I wanted to discuss the potential of IPTV adoption. After all, are we just hoping that UTStarcom breaks even? NO. We have all been patiently waiting for IPTV to break out and UT to reap the benefits. As you know, I am tracking the iptv customers that UT has in China and worldwide (see front of blog to the left side). There are many many iptv and broadband estimates on subscribers in the coming years worldwide and in China. There are only 2 or 3 analysts that really follow UT now and everyone is focusing on profitability (I don't blame them). No one seems interested in estimating the earnings potential if indeed iptv breaks out in UT dominated markets (nice sounding, huh :-).


What kind of growth rates can we really expect? Lets look back at PAS. Here are the most recent subscriber numbers from the PHS MOU group.


http://www.phsmou.org/world/sub_statistics.aspx


Scroll down to the combined worldwide numbers because it shows that PAS didn't take off right away either. From 1996 to 2001, the number of subscribers stayed relatively flat at around 5-6 million. It then doubled to over 10 million by December 2001 and then reached 90 million in 4 years (9 times). From a base of 5m to 90m in 4 years, that is a compound annual growth rate (CAGR) of over 100%! Five million is 10x the current iptv subscribers that UT has in China right now. From a base of 10m, that is still a CAGR of over 70% for 4 years. Most of that growth was in China. While UT has had tremendous mis-steps, they do know about disruptive technologies and has the ability to implement wide-scale deployments as we've seen in PAS. Based on broadband numbers and other iptv penetration rates in other countries, and the fact that the iptv era in China has started, it is now a waiting game before the major breakout. The fact that they can reach profitability by Q4 2008 and in 2009, that is a very good sign that they will be in position to reap the benefits when iptv does breakout. I expect the long term market share may be less than what they have in PAS and reaching 70-90m iptv users in China will take longer than PAS. However, they don't have the threat of 3G and PAS obsoletion as well. They also know that unlike PAS, they can penetrate and dominate other secondary markets (India, Brazil, Taiwan, etc.). Just something to keep in the back of your mind.

Saturday, March 22, 2008

Recap of Exploratory group meeting with management/BOD (2)

Sale of Non-Core Assets - During the last earnings call, management mentioned they were in active discussions to sell none-core assets. Merrill Lynch is assisting in the asset sales. Peter mentioned he was spending signficant time on the divestitures. The potential business units to be sold are the PCD, customs solutions BU, and the mobile solutions BU. Indications are that two of the business units will be sold. At UTs current valuation ANY sale would really jump start the stock price. A share buyback would almost be guaranteed. This is definitely something to look for in the near term.

PCD - How much can the company get for the PCD? This division is set to have revenues of $1.7b in 2008. During the meeting, management indicated that 35% of the revenues will be from internally made designs and that quarterly expenses are about $10m (or $40m/year). Based on 6% gross margins, the expected gross profits will be around $104m for 2008. So, net profit will be around $64m. Motorola's handset division has revenues of $19b but lost $1.2b last year. There is no way they will get 1x revenues for it at this time as Icahn would like. Motorola's entire market cap right now is around $21b. So, how much is UTs PCD worth? Based on the revenue growth, the profit margins, and the steady improvements in UTs own internally made handsets, I would value it much higher than the $200-250m that has previously been discussed. At 7x multiple of earnings, it would be over $400m. At 5x earnings, it would be $320m. The internally designed phones make up about $600m of revenue already. My best guestimate would be $350-400m and it could be conservative. If this were to be sold, then obviously, 2009 profitability will not happen but I think we can all live with having that kind of cash/liquidity right now. There was a recent article (link posted by kr_khous about Dell and handsets (http://blogs.barrons.com/techtraderdaily/2008/03/20/dell-entering-the-mobile-phone-market-in-2009/?mod=yahoobarrons). It seems like other companies may be able to extract more value from the PCD than UT can and drive valuations even higher. The sale of assets specially the PCD would make the stock explode.

Communication - Management mentioned that since their products are relatively new (iptv/ngn for example), customers are hesitant to put out PRs and thus the company cannot disclose contracts until much later or at all. In some cases, just getting the release paper work is a chore and takes a long time. They did feel that things can be improved. Contract amounts could also be added in the future. Some items that could be disclosed simply happen at the last minute. For example, the cash used to repay the CB fully literally came in the last week so a PR could not be issued. Even the intent of paying the CB in full could not be made earlier or last year because they simply did not have the cash in the US at the time and would have had to say they did not have the cash at the time. I think the information provided in the earnings call have been generally good. However, there may simply be not enough time to address each item in extensive detail in the call. For example, the ongoing concern statement. Barton could have tried to work on removing the statement (5% chance of success according to Barton) but they would have had to file the report 30 days late or just take the hit (have the ongoing concern statement) and get it filed. So, they just got it filed, which everyone agreed was better. There are other items that could be tied to communication. Guidances can be refined so its not too conservative and lead to confusion on business perormance or suspicion of lack of control. I guess with the stock at this level, it is very fragile and the company has to be careful in what they say and don't say. That also became an issue with filing the 10K a day late (or even a couple of weeks late). A shareholder even commented on the announcement when earnings will be released. It seems that other companies can announce the date of earnings much earlier than UT can. Barton replied to the effect that they did not want to close the books to early or too late. This may still be part of the accounting switch to the new system but I got the indication that the earnings date announcement will continue to be last minute. There was also no announcement of the OEM that they have already signed and the ones they are still working on. Communication is very important since it is tied to confidence. If communication is poor, confidence is poor and also reflected in the stock price. Management also mentioned that they have spent most of the time in running the company rather than doing roadshows with the investment community.

Overall CEO position and China CEO situation - Peter is set to assume the CEO post on July 1 and will be more active with the investment community (Peter mentioned that hopefully, there would be more good news to announce as well). I had thought that this (CEO spot) was not assured and that if not offered the CEO title, his contract would stipulate some other arrangement. But, it seemed it was already "known". I think this is clearly another communication issue and it would have been great to have a PR on this. There was no update on the China CEO position. Many new managers were hired in China and they are rebuilding since Wu left.

IPTV Strategy in US and around the world - If UT's iptv system is one of the best, then they should be able to penetrate different markets around the world. Blackmore mentioned that they hired Mckinsey a while back to determine which areas they should focus on. Mckinsey mentioned to "double down" in Asia, stay away first from the US/Western Europe, and try to penetrate the peripheral of Eastern Europe and other areas. A shareholder asked about Mexico and iptv. Management also mentioned Mexico as a possibility. Peter also mentioned that they carefully weigh the risk/rewards (expenses/potential profits) on each area as we would hope for. There is also a lengthy qualification period for a lot of the providers so it is not as easy to break in to new customers.

IPTV competition in China/optical/gepon/broadband situation - The recent news in Shanghai of Huawei giving their iptv equipment basically for free and UT having to share the rest with ZTE drew some concerns. Management clarified that Huawei system is so bad they have to give it away and they know UT's system is excellent and there is no need for major price cuts. Huawei and ZTE are very good in other products but they know customers know UT has the best product in iptv. So, those were normal discounts not expected to impact margins. Even if UTs customer gives away the iptv system for free for promotion, they obviously still get paid. The Shanghai news of expansion to 800k users should have been VERY good news but instead got twisted into a concern. As far as the other news of UT being shut out or not in the top suppliers for a recent gepon contract in China, management mentioned UT working to be a 3rd or 4th supplier. These are not big contracts and are usually divided among about four suppliers.

IPTV regulatory issue in India (MTNL) - No problems according to Blackmore.

It should only take one more post to wrap up the meeting recap.

Recap of Exploratory group meeting with management/BOD

On Monday, March 17, 2008, seven shareholders from the group met with Chesha kamieniecki, Peter Blackmore, Fran Barton, and Thomas Toy at UTStarcom HQ in Alameda. It was a productive meeting that lasted over 3 hours. Prior to the meeting, Chesha had asked if we wanted management to give us a presentation or just Q&A. Since we just wanted to go straight to the main topics, just Q&A was preferable.

Fran Barton started with the forward looking statements and to remind us that no material information would be released to the shareholders at this meeting. Peter Blackmore welecomed the group and introduced the management team and the director present at the meeting. He then turned it over to us.

I gave the introduction for the group going over the previous frustration/confusion of shareholders. As people know, the company had a lot of success with PAS but knew that the company plan was to diversify away from China and PAS. As background, the company had a $2 profit/$4 billion estimate for 2005. Anyway, I started my historical reference after quarterly losses have built up in 2005 leading to the hiring of Fran Barton in Aug. 2005 and the massive writedowns in Q4 2005. As an investor, we were hoping for the iptv ramp and return to profitability in early 2007 (as the company had guided). In the early part of 2006, the share price was around $6 when Hong Lu announced he was stepping down and Ying Wu would take over as overall company CEO starting in 2007. Towards late 2006, the stock started moving up to the $10 range. It could be that the market was anticipating profitability but we learned about the strategic alternative study in October 2006. At that time, the stock stayed in the $9-10 range and we learned that Ying Wu would not take over as CEO, Wu would lead the strategic alternative study, and Lu would stay on as CEO. I asked Director Toy what prompted the strategic alternative study and he responded by saying there was conern regarding PAS decline and at the time felt the share price was undervalued. During this time, we had more delays of the filings as well so did not know whether they would achieve profitability in early 2007 as guided.

The first half of 2007 was basically waiting for the quarterly filings, results of the strategic alternative study, and dealing with options investigations, Nasdaq notices of potential delisting, and negotiating with bond holders regarding additional interest payments so that the company would not be in default on the convertible bonds. The stock steadily dropped to the $7 level as we waited for news. At the end of May, we found out nothing happened with the strategic study, Ying Wu was leaving the company, and Lu was moving to China to stabilize the China operations due to Wu's departure. The stock dropped from the $7 to the $5+ level. At this time, there was still no financials out. At the end of June, the company hired Peter Blackmore to be COO and eventual CEO to replace Lu.

The first hard operational data we received from the company in about a year came on July 24, 2007 when the company released a liquidity update. Based on the last balance sheet, the company had NET $260m in cash. However, the liquidiy update showed net cash falling from $300m at the end of 2006 to $150m at the end of Q2 2007. What happened to the profitability guidance and why was there significant burn rate? Add to this a NEW China investigations and further delay (no timeframe) to the financials. The stock dropped from the high $4s to the $3s. As the stock threatened to break $3 to the downside, the company finally had a cc (Interestingly enough I had posted the company NEEDED to have a cc about 10 minutes before the PR came out). Anyway, a new guidance was issued that the company will get back to profitability and be cash flow positive in EARLY 2008 (As Barton explained at the time, Cash flow positive/GAAP profitability were pretty close).

The reason I had to go over (painfully) the past was to find out if the company really had clear direction this time. During the Q&A on the last November shareholder meeting, management basically said you can trust us or you can sell out. I wanted to let management/BOD know that frankly those are not acceptable options to shareholders. I asked them if they truly feel they can turn this around or are we headed for more frustrations/disappointments. After all, they do know the operations more than shareholders and Blackmore has had some time to look at the various operations and can assess the situation. I mentioned that if this cannot be turned around, then it would be better to go into a new strategic study and just sell the company. Blackmore mentioned that they do feel they can turn this around and it would be a mistake to sell now. Great, but they CANNOT just continue doing business as usual. I think Blackmore did comment that he would be careful with "sense of urgency" comments becuase as I had mentioned, there is a difference with the sense of urgency that management/BOD feels and the way the street/shareholders feel. I wish I can say I just bought recently or even a few months ago and can wait patiently but this turnaround and promises/guidances have been going on for a very long time. Anyway, if they are going to try to turn this around, some things simply have to change and thats why the group brought some proposals and questions. With this setting, we proceeded with the various issues the group has outlined. The format would be to go down the list of issues with me giving a brief intro and other shareholders chiming in with management responding. I have to credit management for addressing each point for the three hours. While there were some overlapping topics, we tried to keep to the list. Here are the details on each topic.

Share-price/Stock buyback - During the last cc, the company announced payment of the CB and other short term debt. This was definitely positive but with the all-time low shareprice, investors were asking for a stock buyback. Even way back last year, shareholders already wanted the company to defend the stock price. Director Toy's position is that data they have from previous stock buybacks showed that limited buybacks were not effective. I made it a point on disagreeing with Thomas Toy on this issue. Shareholders went through all the reasons for a stock buyback such as taking advantage of the all-time low price, best return of investment, reduce share count, defense of the fragile stock price, show much needed confidence, etc. How low does the stock price have to go? Management also mentioned that even if they were to do a buyback, they are also in active discussions to sell none-core assets and there are complications with announcing a buyback at the same time. Based on material information disclosures, we obviously were not going to get a buyback announcement but felt they are more likely to do it after an asset sale. Barton already mentioned no stock buyback on the last call but atleast they are thinking about it.

Compensation - I told Fran Barton I have to pick on him because, well, he is a big target. I was surprise to see that Chesha and Toy were eager to "defend" Fran. I know Fran is well-liked but didn't know how well-liked he really is. A little background on compensation. Fran joined the company in August 2005 and took over for Mike Sophie. We learned in this meeting that they did not have the systems he was expecting back then. Fran's salary was $500k and was increased to $750k partially because of this. I was surprised to learn from recent filings he has amassed 1.3 million shares as well. After the last shareholder meeting in November, Fran also was given a retention bonus contract of $2m/year for the next 5 years to stay on. This is on top of yearly bonuses he may earn. My compensation question was general but wanted to focus more on Fran's compensation. Anyway, Thomas Toy is part of the comensation committee and addressed the compensation issue. He explained that salary is based on data from comparable companies with similar market caps and revenues. I would have argued about the revenue part but base salary was secondary to the bonuses and shares issued. He explained that Lu being the founder and having to uproot his family to China deserved the compensation and that he has not had a salary increase in a while. Blackmore is compensated accordingly based on the current situation of the company and demand for quality executives. I think most shareholders would not question the compensation except for the stock performance and inequalities that they see between what management is getting and what they have to risk (and that they know so much less than the insiders). Anyway, getting back to the $2m/year retention bonus. Toy basically said they had to pay Barton for the sake of continuity during the turnaround phase and that good CFOs were hard to find. I think most shareholders are also for continuity. My response to all of this is that Fran Barton really HURT shareholders will all the poor guidance (see intro above). Being an investor, I base a lot of my decisions on the CFO's guidance. Barton's 2007 profitability guidance (that turned into a $1.62 loss!) and the lack of preliminary numbers during the lack of filings really hurt investors. Barton responded by saying they exceeded early 2006 guidance. Yes, they did but even those guidances were WAY off. Being an engineer or any technical person, we cannot be WAY off. Are they just throwing darts here? What good are numbers if they are way off? Some other information. Morningstar mentioned the $1.4m in bonuses paid in 2006 to Wu, Lu, and Barton were excessive. We did learn that there was no bonus paid in 2007 and that 2008 bonuses are tied to a more diverse set of performance metrics. I could probably spend more time discussing this but lets move on. Towards the end, I said "so the BOD approved all the compensation"? Barton was quick to reply that he wished he was able to approve his own compensation and Toy mentioned that obviously the compensation committiee would approve the compensations. Sadly, I think it did not dawn on them that I was hinting at "accountability." Here is the take away on compensation. There may be very good reasons for the enahanced compensation but like a lot of the reasons I heard that day, the end result is bad for shareholders. The fact that the company was driven to this situation actually now makes these guys more VALUABLE? When Fran came in, even Chesha had to help out a lot on the CC. Now, that they have things more in place, they are indespensable. That is just bad math for the shareholders. I believe the compensation topic ended with me saying somethiing about the 11% they let go and that I just hope Fran Barton is worth it or something like that.

OPEX- The company has announced that they believe expenses are still way too high and are looking to cut more. Why can't they cut right away? Some business units that are not profitable cannot simply be shut down because of the impact it would have on customers, who are also buying other products from the company. So, that part is not as simple to do. It would be better to divest those units rather than simply closing it down. Management is still on track to reaching the expense metrics they have guided by 2009 or late 2008. The "core" revenue will include the internal design handsets part of the PCD. They are about to move to a new Oracle accounting system next month (seems like the accounting software may finally be resolved, that also has taken a while because Chesha mentioned they just grew too fast) and are reducing headcount by about a 100. One other shareholder asked if there were other low hanging fruits to pare off and Barton answered positively. He definitely says more can be done. Barton mentioned that it seems they have been revising 2002 financials forever and that accountants are charging a LOT. R&D funds are concentrated mainly on iptv/NGN now, very little on PAS. As PAS continues to decline, SG&A related to PAS will also come down. Another shareholder discussed expenses and that it really should come down much faster. Barton seems to have things in control with the projections for 2009 profitability as he mentioned and pointed to his master plan folder (if someone can steal that folder, maybe we can lay Fran off. he he). Seriously, I think Peter/Fran ARE looking at all expense cuts/efficiency measures but it is just taking some time. Management seems fairly confident regarding getting back to profitability. I think the street is underestimating profitability in 2009 and thinks it will be later. I think most shareholders believe that R&D can be impoved a bit but it is the future of the company. SG&A has to come down much more.

NOTE: Over two hours ago, I had reached this point of writing and was in the process of posting when I found out the internet had been down all along. Normally, there is an automatic draft save by this web hosting site but since the internet connection was down, it wasn't saving! So, I lost everything (exept the first 3 lines) when I tried to post and had to start over. If the writing is a bit "rushed", I have an excuse :-) I'll continue after a late late lunch. Make sure you SAVE your documents.

Saturday, March 15, 2008

Exploratory Group CC on Saturday, March 15, 2008

Here is a link to the recording of the conference call. Thanks to the people who participated.

http://www.4shared.com/file/40904230/5574cdbd/UTStarcom_Exploratory_Group_CC_3-15-08.html?dirPwdVerified=255ed8e3

This is a different file sharing service site and allows comments to be added.

Wednesday, March 12, 2008

Exploratory group shareholder CC this Saturday, March 15, 2008 at 10AM

Thanks to everyone who commented on the list of proposals/questions/topics that we will be discussing with management on Monday, March 17, 2008. I appreciate all the comments from the one-line supportive emails to the three page thesis. For the most part, there are consensus on various topics such as expenses, compensation, profitability, defense of the stock price and other topics. However, there are obviously some differences in the approach/opinions as well. I will be holding a shareholder conference call this Saturday, March 15, 2008 (10AM US West Coast time) to go over some of the key proposals/topics.

I have also recently communicated with some fund managers and want to share some of their insights on the company, their vision for the company, why they own the stock (and in some cases bought more recently). I've also had the opportunity to have some email correspondence with Chesha Kamieniecki (UTStarcom Director of IR). She clarified the building issue (as I posted previously) and had some thoughts on the performance of the company, which I will share with the group.

The call will last approximately one-hour and would advice people who are using a microphone to turn it off so that it doesn't echo back (it was difficult to listen to some of the speakers on the previous call). For organizational purpose, I will basically speak for the first 15 minutes or however long to get through the key proposals/topics and then open it up right away for general discussion. As time permits, we will go through as many of the topics that people want to discuss. During the meeting with management, I hope to discuss the main issues and will leave a copy of the list with management and IR. Due to the number of topics, I'm sure we won't get to all of it but hopefully can get answers to them in the future from management/IR.

I will send the CC info out to the group so check your emails (bulk folders as well).

Saturday, March 8, 2008

Valuation

How much is the company worth? Some would remark that it is worth $2.81/share (the closing price as of March 7, 2008). Some would point to book value (shareholder equity) of around $5/share. Some would assign a multiple of revenues. Some would do a discounted cash flow analysis. The problem is things change all the time and estimates over a year (or even a quarter) are not very accurate for UTStarcom. Based on the latest information from the last Q4 2007 report and guidance for 2008, and clarifications from IR, I will just post some "factual information" and come to a ballpark estimate that we can use to track from here.

Property Plant and Equipment - At the end of 2007, it was stated at $431.6m less accumulated depreciation (222.5m) yielding a value of $209m. This has not changed much from the end of 2006 at $213m. Recently, there has been a lot of discussion that the Hangzhou building alone was worth anywhere from $250-450m. I got some clarification from Chesha Kamieniecki.

The initial cost of the building was around $165m and UT started occupying it in 2004. The land is on a long term lease and UT receives a special high tech tax status for it. The company has repeatedely mentioned it cannot sell it due to various reasons (one being the tax status). It has 2.7 million square feet of space and about 2/3 occupied from the latest filing. You can actually see the facility from the outside (check U-tube). According to Chesha, they are under discussions to lease the excess space. She mantioned "....decision in the fourth quarter to outsource our handset manufacturing. At the same time, we are working with our handset outsourcing partner to lease our manufacturing space in Hangzhou. Thus having the double affect of improving working capital and providing income on the building. This is in the process of going into effect, so these results will most likely be in a few quarters." The latest appraisal was in October 2007 and valued it at $180m.

Personal Communications Division (PCD) - This division makes up their own internal design handsets (non-PAS) and the unit the company bought from Audiovox for $165m (plus some debt/inventory). Back in 2004, this division was at a $800-900m yearly revenue run rate. Margins have increased from 2-3% to 6.2% this year. It had revenues in 2007 of $1.664 billion and projected to grow by 4-5% more in 2008. During Q4, the division shipped 2.8 million units. Internally design handsets have steadily climbed as a percentage of overall units reaching 50% in Q2-Q3 2007. It is now about 25% due to the large increases in volumes. This unit is set to bring more than $100m ($107m estimate) in gross profits to the company in 2008 with little expenses tied in with the Terminals Business Unit. This unit has been the most discussed regarding a potential sale as it was classified as non-core. Motorolla has also been under pressure by Icahns investment group to sell their handset division. They see the Motorolla division worth 1x revenue or $20b. It will be hard to get anywhere near those valuations for Motorolla or even UTs. Most people have discussed a $200-250m conservative valuation for UTs PCD.

Cash - At the end of 2007 and as of the last earnings call (2/28/08), net cash was at $180m. The company has paid off the entire convertible bond plus interest of $289m. They also paid about $92m in other short term debt this quarter. There was a "going concern" statement that auditors will make because of the reduction in cash due to the two events and the recent cash burn and losses for 2007. Management made a strong statement of not diluting the existing shareholders by paying off the debts with existing cash and in the recent Merriman conference squashed liquidity concerns by saying they do not need to tap markets due to their adequate cash and improved performance going forward. They are also seeking ways of additional cash generation by a number of means (see my summary after the latest cc).

Rest of the company (not including PCD) - This includes the iptv/NGN/PAS division (MCBU), BBBU, TBU, Services, and Others. From the filings, I gathered a few numbers for 2007 and the projections for 2008 (using the mid-point of guidance in rev/GMs). In 2007, the "rest" had revenues of $803.5 million and gross margins of 28.3%. In 2008, it will have revenues of $838m (4.3% gain) and gross margins of 33.3%. The main negative year over year will be PAS (as expected). Another major concern is Japan. In 2007, revenues decline to $70m from $137m and $479m in 2006 and 2005 respectively. Their main customer (and large shareholder) Softbank has shifted their focus to wireless with their Vodafone purchases. Shareholders have focused on loss sales from PAS in China but Japan is also a source of concern but also of potential growth in the future. This is one area we will discuss with management during the meeting in March 17. The positives for 2008 include the 5% improvement in gross margins, the 4.3% revenue gain despite PAS declines and strong growth in iptv/ngn revs, broadband (GMs from 4% to over 20% for each quarter in 2008), and "others" with the commworks group increasing revs to $40m (100% gain) and GMs in the 70-80%. This group is also non-core and could be sold. Part of the "others" group (the commworks or CSBU) was purchased from 3com for $100m back in 2003. It is now starting to do very well and will be profitable in 2008.

If you place a 0.5x revenue multiple on the "REST", it will be $420m. At 1x revenue, it will be $838m and so on. The fact that they do not expect to be profitable until Q1 2009 or Q4 2008 at the earliest puts a cloud on valuations and a discount on even current assets (S&P has a $3.5/share target based on 0.7x book value).

My personal thoughts are that the company is making strides in explosive segments on the market and on emerging countries and winning many strategic contracts and gaining impressive market share that the street is misvaluing the "REST" and focusing on PAS declines, management poor historic execution and low margin PCD.

If we add the Hangzhou property alone ($180m) + PCD ($250m) + net cash ($180m), that would yield $610m. The building and net cash alone is worth more than the current market cap. So, the current penalty/discount is the entire PCD and the REST. People can argue and debate the timing of profitability but we have a lot more confidence that it will be soon with the expense cuts and contracts/bookings we are seeing. You can discuss the management mis-steps (and we will during the upcoming March 17 meeting) but we have a new COO and eventual CEO in Peter Blackmore that seems to have reinvigorated the company- I don't want to give him all the credit but he is the symbol of the changes we are seeing. According to Chesha, most of the management team (except for Hong Lu) has been in place only the past 18-24 months.

In summary of this valuation post, it is clear that the market is discounting the assets, future earnings, and franchises that the company has spent the last decade in building. Reasons such as historical mis-steps, weak internal controls, lack of confidence in management and lack of profitability come up very often but progress is being made. I see the signs of paying off debt, winning contracts, better communications (in the CCs) as concrete steps in the major turnaround unfolding before our eyes. The reasons for the discount are still there and we want management to address those items. It will not happen overnight but I am very comfortable with the valuation aspect of the company even 8 months ago and definitely more so now that the future operational performance have never been better (since the glory days of PAS). As for shareprice to valuation, it definitely has not been better at any point in the company's history.

Friday, March 7, 2008

India Telecom Landscape and UT's Strategic Wins

Lightreading had a nice article on the telecom landscape in India.

http://www.lightreading.com/document.asp?doc_id=147300

On the fixed-line side, BSNL dominates with 31.6 million subscribers, followed by MTNL, Bharti Airtel, Reliance, Tata, and a couple of smaller ones.

http://www.lightreading.com/document.asp?doc_id=147300&page_number=1&table_number=1

UT recently announced during the Merriman conference that they had won a 3rd and 4th iptv customer but cannot announce them yet. We know UT has won with MTNL and Bharti and Microsoft has teamed up with Reliance. The wins with BSNL in the broadband area suggests that the two new wins are with BSNL and probably with Tata. Because of the skewed number of lines that BSNL has, winning 4 out of the 5 iptv customers would mean almost 97% of the potential iptv market. The number of broadband lines able to support iptv is nowhere near what it is in China but the strategic wins in India show that both the BBBU and MCBU will have a strong pipeline of contracts and growth for years to come.

Unlike in China, the wins in India are even more attractive to potential suitors such as Ericsson, Alcatel-Lucent, NSN, Cisco, Nortel, etc who are trying to expand into high growth countries that don't have local equipment providers (such as in China's ZTE/Huawei). While UT has had problems with their initial contracts in India (with writedowns of $30m in 2006 and 8m last quarter), management has indicated that gross margins in the broadband unit will be over 20% in each quarter for 2008. Hopefully, they have turned the corner and learned from their past contracts in India and can fully take advantage of the growth in India.

One last note regarding the India landscape. Back in late 2006, Merrill Lynch's report on UTs prospects did NOT even include India IPTV and India revenues at that time was only in the $20-30m/yearly run rate. Sooner or later, the market will catch on to UTs progress in IPTV and India and may even give the company a little bit of credit (valuation bump) for it.

Tuesday, March 4, 2008

Wimax - Tata or BSNL in India ?

A few months ago, we noticed some nifty Wimax gear from the UT website and started speculating on potential contracts with BSNL.

http://www.utstar.co.jp/Company/Events/07interop/WiMAX_e.pdf

http://www.lightreading.com/document.asp?doc_id=136729

Today, Tata unleash its wimax deployment.

http://www.unstrung.com/document.asp?doc_id=147494

UT announced on the earnings call and on the Merriman conference that they had won a 3rd and 4th IPTV contract in India and those are probably with BSNL and Tata since Reliance is working with Microsoft-Alcatel-Lucent. While Tata contracted with a local vendor Telsima for its wimax deployment, it is also looking to add other vendors and UT could be in the running. UTs wimax gear is formally the Moving Media 9000 and its part of the Mobile Solutions Business Unit (MSBU). This business unit supports IPCDMA, GSM solutions. Growth is in the 30% and gross margins are expected to be in the 40s in 2008. It would be a tremendous boost to this business unit if they can win in India and showcase their gear. There seems to be a ton of wimax business to be had and UTs investments and products coincide with the market demand in India.

"Tata isn't the only operator with WiMax plans in India. Some have described the market as being poised for a WiMax "big bang" as operators prefer to build out significant portions of their networks before making formal launch announcements."

Monday, March 3, 2008

New All-time closing low - two new India IPTV wins

UT closed at an all-time low today at $2.49. The Q4 result exceeded expectations on the top and bottom line and so did preliminary 2008 guidance so what happened. The stock started off well last Friday (above $3.1) but reports late in the day surfaced that UT was going to delay their 10k filing (see terminal updates) and there was a reiteration of a hold and lowered price target from $4.25 to $3.

http://tim94305.googlepages.com/UTTerminalUpdates.tif

In addition to the "going concern statement" that management discussed in the call, additional items showed up in the terminal of traders this morning such as:

UTStarcom cites material weakness, sees significant change from prior year, and the delayed 10k. Coupled with the weak market this morning, the stock opened at $2.45 and hovered at $2.5 for the rest of the day ending at $2.49 on almost 3 million shares (prior days saw very low volume under 1 million shares on some days).

There was also a note on a Morningstar review but that was positive.

"We're placing UTStarcom UTSI under review while we revisit our valuation, taking into account the firm's newly released fourth-quarter and full-year results and 2008 guidance. We expect an increase in our fair value estimate."

During the day, I sent an email to Chesha Kamieniecki (UT Director of IR) to hopefully have Peter Blackmore or Fran Barton addressed the filings issue and material weakness/internal control issues during their conference in San Francisco (Merriman Curhan Ford & Co. Annual IP Video Conference at the St. Regis Hotel in San Francisco, CA.).

During the end of the call, Peter addressed the filings and liquidity issue saying that the filing will be done later today or the next day (10k was subsequently filed in the afternoon). Peter also wanted to squash "rumors" regarding the company's liquidity situation and said they had enough funds and do not intend to go to the markets at this time.

Interestingly, Peter Blackmore also disclosed not only a 3rd win in India but also a 4th win! Also, Chesha mentioned:

"Thanks for the note. We will address the filing on the call today. With respect to the internal controls issue; these are not new and have been fully disclosed in our 2006 filing. In fact we reduced the number of material weaknesses from 9 to 3 in 2007."

It does seem like there is an over-reaction by the market to negative headline news but the damage has been done. Rather than the stock being at $3.2 or higher as it was in the premarket on Friday, it is at $2.49 at the close on Monday.

There is no doubt the communication could have been better. The company could have even pre-announced the quarter (20% revenue upside), announce contract wins in Italy, iptv wins in Sri Lanka, full payment of the CB and other positive news. There were also negatives in the report such as the $8m loss in India and the $23m non-cash writedown. However, overall, Q4 was very solid and the outlook for 2008 coupled with strategic wins were very positive. I just wish the good news would be circulated and communicated as well as the rumors or the "bad" headlines news.

Sunday, March 2, 2008

UT IPTV Worldwide and China Subscribers

On July 6, 2005, Softbank launched their iptv service powered by UTs M-vision (what it was called back then).

http://www.prnewswire.com/cgi-bin/micro_stories.pl?ACCT=159138&TICK=UTSI2&STORY=/www/story/07-06-2005/0004062192&EDATE=Jul+6,+2005

On November 2005, China Telecom officially launched their iptv service in Shanghai using UTs solution with a modest 5k target that drew a lot of headlines since Shanghai had 13 million people.

http://www.lightreading.com/document.asp?doc_id=84314&WT.svl=deptfin_1

Back then in late 2005, the stock was already "struggling" but managed to surged to the $8-9 range briefly on the news that this was THE turnaround. Obviously, it wasn't. As before, the market is still waiting for the growth in IPTV. During the strategic study by ML in late 2006/early 2007, they highlighted iptv as UTs potential savior but didn't have a good handle on when IPTV would take off and what their situation all over the world.

At this time, UT has shown that it has maintained market share and steadily growing the business in China and worldwide with wins in Japan, China, Inida, Brazil, Taiwan, and Sri Lanka. Strategic wins in the broadband/Pas areas in Italy, Philippines, Pakistan, Argentina, Chile, (Mexico, Russia, Turkey not publicized but...) show that UT has its foot in the door in a lot of places as well. Recently, UT has been providing subscriber numbers worldwide and in China and I have collected and will maintain those numbers as it is critical to one side of the profitability equation. The numbers are directly from UTStarcom, either though a PR or a source mentioned in a particular article.

http://tim94305.googlepages.com/UTIPTVSubscriberNumbers.pdf

In China, from the November 2005 start, subscribers grew to about 200k by end of 2006 and to 385k by November and 500k by end of January 2008. By end of 2008, it should be around 1 million just on the number of STB shipping currently. I was going to post potential iptv subscriber growth in China and worldwide but that is a futile exercise as the numbers are all over the place and have been off by a lot in recent years due to uncertain regulatory environment, which still exists today. Most of those predictions in iptv subscribers come from the number of broadband users and penetration rates that iptv can achieve. Since those reports are not worth the paper they are printed (I wonder if those companies charging for them give refunds when they are so off), I will just go with some broadband data I plucked out from the web this morning.

"China ranks second in number of broadband users worldwide People's Daily,June 7, 2007 - Zhao Houlin, Vice Secretary General of the International Telecommunication Union (ITU), said on June 5th that China now has 97 million broadband users. This number of broadband users ranks the second only to the US. The development of the broadband communication industry has gained worldwide attention. At the opening ceremony of Broadband World Forum Asia 2007 held by the China Network Communications Group Corporation, Zhao Houlin said that by the end of 2005, 74 percent of global broadband users were from developed countries, and China made up 17.5 percent. China's rate of broadband popularization is the fastest among developing countries. Zhao Houlin said the ITU expects that "China's successful experience can be used as reference and be applied in other countries, thereby helping to narrow the gap between broadband users the world." At present, China's broadband users has exceeded 50 million; of which China Telecom's broadband access users has exceeded 30 million, and China Netcom's broadband access users has exceeded 20 million."

http://www.chinatoday.com/it/it.htm

The numbers are all over the place but broadband users (and the quality of the broadband connections) are going much higher than whatever iptv uptake currently is in China and worldwide in UT markets. Prior to 2007, we only had contract wins but its good the company is providing numbers whenever they release an iptv related PR (as we had wanted them to :-).

I don't want to be overly excited since the penetration rates are still way low and the company is still struggling. I also want to highlight the fact that in the Softbank PR, you could already see the company deploying Rolling stream, Gepon, IPDSLAM and other technologies, which tells you that the company has been spending a ton of money in R&D for a long time to get to where they are (either maintaining those technologies or developing new ones) and they are still not profitable. That is something we need management to discuss with shareholders and the market in general. We are a long way from where we want to get but tangible contracts/subscribers in iptv are validating the potential (not necessarily the return of investment).

UTStarcom competitor ZTE and Philippine National Broadband Network (NBN) and Cyber Education Projects (CEP).

How difficult is it to compete with ZTE in the international markets?

A quick background of the "size" of ZTE,

"First, as a global enterprise and China's only publicly listed telecommunication supplier both in Hong Kong and Shen Zhen, ZTE has made great achievements in business growth during the year 2007. The turnover of the first 3 quarters has increased 47%, and the annual profits are expected to increase by 50-70% in fiscal year 2007. ZTE has set its goal of $10 billion US dollars for global sales in 2008."

http://www.abs-cbnnews.com/storypage.aspx?StoryId=109164

Currently, there is a major bribery scandal in the Philippines involving ZTE and Philippine governement officials (all the way to the President's husband).

"The Philippine government in April 2007 awarded CTE a US$300 million-contract to build a broadband network to connect all government agencies and offices across the country. The project was later scrapped after allegations emerged that the deal had benefited high-ranking officials through commissions and kickbacks."

http://www.businessweek.com/globalbiz/content/feb2008/gb20080220_073482.htm?campaign_id=rss_daily

The Chinese government was going to loan the entire amount of the contract with loan payments not starting until 2012.

http://www.gmanews.tv/story/61876/Arroyo-Bribery-talk-over-ZTE-deal-was-uncorroborated

There are now hearings into this matter and officials from ZTE and the Chinese government are being called to testify. Obviously, they are refusing and instead using the massive trade between the two countries as leverage and instead trying to turn it around and saying this will discourage trade between foreign countries and the Philippines.

That is a tough situation for UTStarcom to compete against. The shear size of ZTE ($10b in revs and the backing/credit of the Chinese government) make it almost unsurmountable. However, they have managed to win at PLDT and is even using this as a showcase to win more projects in the region (and even in Italy with Tiscali very recently). Hopefully, these cases of corruption against ZTE will help UT in securing more wins as governments avoid the potential controversy in dealing with Chinese backed companies.

With the current very succesful PLDT win at hand, UT should go after the National Broadband Network (NBN) and Cyber Education Projects (CEP) in the Philippines that ZTE did not get and involved in the scandal. This is another discussion point we can bring up during the meeting with management.

Saturday, March 1, 2008

Q4 2007 results and 2008 outlook

This latest earnings call will be remembered as the time the company paid down their entire convertible bond debt + interest, a whopping $289 million using existing funds from the US and those transferred from China.

While I am happy that they chose to pay it off completely, it does raise the question, why they didn't do this LAST year? Why pay the additional $22 million in interest payments on top of the $14 million in regular interest. I know they got lucky with the gemdale/infenera ($90+ million take) but was it worth having the CB cloud hang over shareholders who were peppered with endless PRs regarding defaults and uncertainties. I know market conditions change but paying $36 Million in interest payments last year is ridiculous and shows a lack of planning to resolve this. They could have easily saved half the interest payments and transferred China funds years ago.

http://messages.finance.yahoo.com/Stocks_%28A_to_Z%29/Stocks_U/threadview?m=tm&bn=27187&tid=150000&mid=150000&tof=46&frt=2

After listening to the conference call twice and jotting my notes, there were some negatives but overall one of the most positive calls over the last 3 years and basically solidifies the longterm case for buying UTStarcom.

Peter Blackmore discussed the various business units, Hong Lu talked about China progress, and Fran Barton recapped Q4 numbers and outlook for 2008.

As you many know, there are six business units. The multi-media communications business unit (MCBU) includes IP-based technology and soft-switch related items such as IPTV, Next Generation Networks (NGN) and PAS.

Late in Q4, Tiscali of Italy decided to replace all of their TDM switching network with UTs MSAN equipment. This is a huge strategic win and being implemented already. Blackmore also mentioned recent wins in Taiwan, Brazil (Brazil Telecom), Thailand (TOT), and Argentina (Nextel) and feels that UT has the best soft-switch technology in the market.

IPTV- Currently over 750k subscribers, up from 600k late last year. That is huge growth of 25% in a little over 2 months. Aside from wins/expansions in China, they won in Taiwan (Markwell cable), Sri Lanka Telecom (SLT) and a new customer in India. Rollouts will predominantly start in Q2 and there is the usual 6-9 month revenue lag so these are nice strategic wins. Market share in IPTV in China is greater than 65% and well over 80% in India. More info from Lu in China but momentum is growing and there are lots of "activity" in this area. IP Surveilance (2 wins in China, more from Lu later on).

For this division (IPTV/NGN), Peter mentions "Booking can ramp up fast" and revenue growth will in greater than 80% for 2008. The MCBU will have flat revenues due to the decline in PAS. Gross margins will be 35-40% (including STB). Overall, the revenue bookings have caught up to PAS decline, which is good news. Seventy percent of the revenues planned are already supported by existing bookings which give them greater certainty for 2008.

Broadband Business Unit (BBU)- This includes IP-DSLAM, IAN8000, GEPON, and Netring. This will have 15-20% revenue growth in 2008 and support triple/quadruple play buildouts using both copper/fiber. UT is one of top 5 vendors in GEPON worldwide. Netring is the optical product that is already in 3rd generation. Gross margins are going to be above 20% for every quarter in 2008. This is key because GMs are sometimes negative in 2007 with writedowns for poor performance previously. Thirty percent of the revenue planned has alreadyy been booked.

Services Unit- Flat revenues are expected for 2008 with 30% GMs. This is expectated to ramp in the following years due to the new equipment being installed with new customers in 2008 and beyond.

Terminals Business Unit (TBU) - Supports handset business (CDMA and PAS). Overall growth of 15% in 2008. Looking for additional growth in WCDMA and in area in telematics (won some initial contracts in automobile industry). GMs in low 20s range.

Customs Solutions Business Unit (CSBU) - Mostly includes technogy acquired from 3coms Commworks unit. This includes IP-based messaging and transaction products. Revenue is expected to double to $40m with GMs above 50%. This unit is also expected to be profitable in 2008. Blackmore mentioned some of the "none-core" assets are becoming very attractive and this along with the PCD definitely fits the bill. What is this business unit worth alone? The company paid $100m to 3com a few years ago and has finally gotten this to profitability this year and growing very fast. This alone could be worth close to $80m-$100m if sold (based on 2-2.5x revenue for this type of business - check Starent/Infinera for valuations).

Mobile Solutions Business Unit (MSBU) - This includes the moving media 9000 and supports IPCDMA, GSM solutions. Growth is in the 30% and gross margins in the 40s in 2008.

Note that the CSBU and MSBU are consolidated in the "other category".

PCD - "Continues to exceed expectations." Three new smart phones released including a touch screen phone in Sprint, ultra slim phone (1450 model metro pcs), and refresh of the Gzone phone (verizon). Shipped 2.8 million units and had record quarterly revenue of $560m with 6.2% GMs, (wow). Twenty five percent of units are internally made UT handsets.

Supply Chain comment - outsourcing of terminals business and improved inventory turns (improve by 35%). Overall margin improvement of 3%.

Peter summarizes (like a CEO) that they are focusing on building their core businesses and manage/divest none-core to benefit shareholder value.

Hong Lu followed with a China update. Recently, China regulatory change - Both telecom/broadcom operators can compete in each others field. CT/CN may be able to offer iptv freely throughout China. This is big news if indeed interpreted this way. Lu gave an update on iptv demand. STB shipments signficantly jumped in January to a 60k/month run rate from 20k/month late last year. Currently, it is at 40k/month. While the regulatory issue is not clearly resolved, CT/CN is ramping up iptv and has made it a priority for 2008. Hong stated that China iptv subscribers are about 500k at the end of January so China is the main growth driver for the company (as we know). China bookings is also expected to ramp up this year and will translate into major revenue streams in 2009 and beyond (as we have hoped for a long time).

Here is Tigre's posting regarding this topic this morning.

http://messages.finance.yahoo.com/Stocks_%28A_to_Z%29/Stocks_U/threadview?m=tm&bn=27187&tid=150092&mid=150092&tof=3&frt=2

A second major change is the long talked about reorganization in the China telecom industry (probably as long awaited as 3G licenses). Anyway, the reorganization will probably have 3 major carriers with China Mobile, China Telecom, and China Unicom. Impact to UT is downward pressure on PAS. On the bright side, it will allow UT to sell CDMA handsets and broaden their customer base (since they can all compete in fix and mobile markets). Hong also mentioned packet mode technology is compelling since it has faster data rates than current CDMA/GSM data rates.

PAS gained market share in Q4 and early 2008 by switching to distribution model from direct sales model.

IPTV will take time to mature. I believe LU is being cautious to mention that it has not openned up completely and obviously it is just at the beginning. 70% market share (slightly higher than what Peter said).

IP survielance wins and Tunchin and Hangchou. Additional opportunities in government and health departments.

Using iptv to get into enterprise and advertising markets.

Upgrading PAS soft switch to release 5 and improving opportunities broadband access. and optical networks. Increased employee morale and higher business activity in China even with the Q4 restructuring. Government representatives/customer visited UT to show support.

Fran Barton discussed liquidity and financial results. Convertible notes due on March 1 was paid completely ("successfully"....hmmmm, not sure about that).

Going concern modification seemed very negative but is really based on historical actions. The company drained a ton of cash by paying the CB ($289m) and $92m for other short term debt.

The company is taking steps such as (1) Q4 restructuring, (2) refocu direct sales efforts to productive areas, (3) using OEM, (4) reducing inventory via improved supply chain/outsourcing, (5) potential sales of non-core assets (active ongoing discussions), (6) license/sale of patents, (7) additional lines of credits (public/private financing), and additional reductions.

At year end 2007, Cash/short term securities was $503m and $320m in debt. This is net $180m in cash. Currently, they have $228m in cash and only $48m in debt. Comment: Debt to equity ratio is down to less than 0.1. If they can sell additional assets or drive to profitability soon, the valuations start becoming very apparent.

Here is a summary of revenue in the business units in Q4, Q3 revenue comparison.

MCBU - $118m , 57m
BBU - $51m, 41m
TBU - $43m, $59m
CSBU - $6m, $2m
MSU - $1m, $10m
Service - $18m, $19m
PCD - $560m, $458m

Book to Bill was 0.8 - not bad considering the 25% increase in revenue from Q3 and traditionally strong revenue recognition in Q4.

GMs for business units (see filing)

Bad news - OPEX was $155m due to restructuring, non-cash impairments, and New taxes in China for Gemdale sale and other income taxes. The GMs for BBU was also negative with an $8m loss provision in India. I think the reason Barton did not preannounce was also because of these "hidden" negatives. While there is a lot of positives, its these kinds of things that make the market think twice. Heman Chou, one of the analysts asking a question asked Barton last quarter if there was any more write downs and Barton said no (my recollection). Barton NOW says he hopes he did not say anything foolish like that, but he did say no more writedowns last quarter and now this again.

2008 preliminary guidance - 3 to 6% revenue growth. This is above any estimates that I have seen specially on top of the $160m higher Q4 2007 revenue reported. GMs of 14 to 16% is what I expected. It is good in that BBU GMs are going to be above 20% every quarter (if there is no more surprises). Expenses for the first couple of quarters are still $115-120m (this is disappointing). For the back half of 2008, expenses will be under $110m (Barton mentioned the company would like it to be lower and KNOWS it has to be lower).

I will post again later regarding GMs of BUs and more anlaysis on 2008 and some of the Q&A, which had a lot of info.

Overall, very good call for 2008, and potentailly GREAT 2009. For the next 3 months, I would say neutral because Q1 is going to be worse and then things will start to improve dramatically. Based on the report and new items, I have much more questions and data to discuss with management in two weeks. I'll definitely circulate those thoughts to the group and we may have another shareholder cc before meeting with management.