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.

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!

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