Saturday, May 10, 2008

Value of UTStarcom's PCD

I've written about UTs PCD and its potential sale before. This division has been designated as none-core so its natural to speculate how much UT can take in. Here is an initial background post in December 2007 where I discuss the PCD and Motorola's own handset division.

Overall, worldwide handsets are set to grow again in 2008 but not everyone is doing well. The industry is fragmented and consolidation is ripe with Nokia leading the market and approaching 40% market share. In addition to Motorola seeking to sell its division, the following developments have taken place.

Lenovo - "PC maker Lenovo Group said yesterday (Feb 2008) it will offload its handset business for $100 million to a group of private equity firms to boost profitability."

"Lenovo's handsets were sold primarily in China, accounting for $108 million in revenue during the quarter ended on Dec. 31, 2007. That figure represented 2.4 percent of the company's total sales during that period. During the quarter, the company reported that handset shipments declined by 31 percent compared to the previous year."

The company eventually unloaded the division on March 31. I don't have a yearly revenue but extrapolating the quarterly revenue of $108m, it was probably around $400m/year but revenue was declining substantially and most if not all of the sales were in China. I also doubt if it was profitable.

Huawei - "China's Huawei is reported to be considering selling a stake in its mobile phones division to foreign investors in exchange for access to the US market." "The company doesn't publicly release breakdowns of the revenues or profits of different divisions, but the sources told the newspaper that the division up for sale is profitable and that the sale isn't meant as an exit from the business. The company was recently reports as aiming to increase its handset production to 50 million units per year. Huawei currently outsources its handset manufacturing to Thailand based Cal-Comp Electronics and Singapore headquartered Flextronics."

ZTE - "ZTE USA, the United States subsidiary to Chinese company ZTE, today announced that MetroPCS has signed an agreement to purchase ZTE’s CDMA PCS and AWS handsets. The agreement marks the company’s first handset customer in the United States."

ZTE and Huawei both want to get into the North American market and have often been mentioned as potential bidders for Motorola's handset division although the size of Motorola may preclude that.

UTStarcom - 2007 sales of the PCD was at $1.664 billion, up from $1.34 billion in 2006 and $1.37 billion in 2005. The company shipped 2.8 million units and had record quarterly revenues in Q4 2007 of $560m and 6.2% GMs. Profit margins in 2005 and 2006 had been 4 and 3% respectively while it improved to 6% in 2007. For 2008, revenue is expected to be 1.74 billion and bring in gross profits of about $104m (up from $94m). The margins doubled from 2006 to 2007 due to higher average selling prices and large inventory write downs in 2006. Overall, the company shipped 1.5m units more in 2007 compared to 2006.

Impact of PCD to UTs bottom line - In 2007, the PCD made up 67% of the company's overall revenue and 30% of gross profits so even though it is "none-core", it has become a vital part of the company. About 35% of the revenue come from internally designed hand sets, up from 10% just a few years ago. At the same ratio, revenue from internal designed handsets will be 608m and 1130m for the resale component. If the company was to keep the internally designed portion and sell the "resale" portion, revenues will still be about $1.5 billion. We don't know what the exact margins for each division but assuming 12% GMs for the internal handset portion, the resale part will have GMs of 2.8%. Profit breakdown will be $73m and $31m.

Valuation - For the entire PCD, I am estimating it could be worth about $500m (higher revenue multiple from the Lenovo sale) due to its North American customers, increasing revenue and average unit selling prices. The division is very profitable and would be an attractive acquisition. From previous discussions, it is very difficult to get into the North American market and establish good relationship with the Verizons etc. The company has also mentioned it is on its 3rd generation of handsets and see continued growth. Based on gross profit breakdown, the separate portions could be worth $350m and $150m (5x gross profit) respectively. If the company keeps the internal design portion and hit their target of 25% of revenue for SG&A and R&D, that would be about $400m in yearly expenses (based on $1.6b of revenue in 2009 without the resale portion of PCD). That would average out to $100m/quarter. The company is targetting to get under $110m by Q4 of 2008.

Impact on 2009 earnings - Using some rough numbers at this point, the company could have $2.8b in sales and overall GMs of 16% (using Q1 GM). That would yield $450m in gross profits and yield to about breakeven if the company reduces expenses to under $110m per quarter (add in stockbased expenses/taxes). The company could sell other none-core assets to raise cash or take in massive cash from a sale of PCD but it would impact earnings in 2009 as the other business units will not be close to making up for the loss gross profits (obviously). Either way, expenses need to go down and a sale of none-core assets is expected. We'll keep up with the news with Huawei and Motorola (and other handset news) but in general the PCD is a valuable asset that can be sold to raise significant amount of cash or maintain their enormous quarterly expenses until the core business units can become profitable on their own.

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