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.

1 comment:

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