Saturday, June 14, 2008

Analyst Day, June 10, 2008 - Commentary

I listened to the 3-hour recording last night and re-listened to the Q&A portion again this morning so that I can properly evaluate all the information provided (and there was a lot). Rather than repeating every single piece of information, I'll discuss some topics and provide more commentary than usual.

Management/BOD - The analyst day was well attended with independent directors T. Toy, J. Clark, and B. Ryan attending. Company executives including P. Blackmore, F. Barton, H. Lu, B. Caskey, and D. King gave presentations. A "panel" of China executives were asked questions to further give insight into the company and its technology. Towards the end, Peter Blackmore commented about the strength of the management team. As a shareholder that has been following the company for the last four years, I can only say that the management team/BOD has ranged from poor to borderline criminal. Thats really the only conclusion I can make since the stock has plummeted from the $40s to $2, the numerous whiplash in strategic directions, the lack of communication/financials and the SEC/DOJ investigations and personal fines some of the executives have had to pay. While Barton discussed improvements from 2007 to 2008, I was wondering to myself would any new investors or the street support a company losing $75m that still cannot get the cost base right after more than 3 years in the RED. I was actually embarassed from owning shares in the company with such horrible numbers. I was wondering what the BOD and management were thinking when seeing those numbers. I understand why they did show the numbers and I own the shares for the valuation but just seemed very weird trying to impress "new faces" with the performance and issues going forward. Maybe the new faces where shorts or maybe people were there for the free lunch :-)

Peter Blackmore as CEO - Since he started, Peter has expressed his enthusiasm for the company's technology, their target markets, their R&D/manufacturing base and all the positives investors like myself bought into the company 4 years ago. The difference is that Peter came in basically when the stock was in a free fall and during his tenure was mostly under $3. I have on ocassion said that a cave man should be able to enhance shareholder value. Having said that, I have liked Peter since meeting him in the shareholder meeting last November and through all the subsequent conference calls, he has managed to explain their strategy and focus. What I heard yesterday though was still little progress to get to core profitability.

Major questions - Listening to the presentation, I started questioning whether (even NOW) the company has a plan to make money or can make money in the future. Its fascinating to hear the "talented" executives and the great technology (Passive Transport Network) that is atleast 1 year ahead of the competition and how great the payback rate for the carriers. However, at the end of the day, can the company receive more money than it spends? During my discussion with Hamed Khorsand (BWS Financial), he mentioned one of the major problems of UTStarcom is that carriers simply want multi-vendor suppliers. UT has had a history of great technology but difficulty in breaking in with Tier 1 carriers for their suite of products. As I posted previously, a lot of technology was devloped 5-10 years ago (look at technology supplied to Softbank). The company continues to spend for a wide variety of technology that may or may not gain traction. Obviously, as a tech company, they have to roll the dice on some of these but they have done a poor job in converting these to revenue. The type of carriers they tend to win now are 2nd tier carriers who are "taking a chance" with their technology. Most of the sucesses/wins they showed were in 2007-2008. When talking about their iptv end-to-end system, they noted they had to developed the entire platform because no one had it then. While the engineers/R&D may be first rate, it doesn't do shareholders a lot when management/BOD cannot control the budget and forecast properly. Being an engineer (Ph.D in geomechanics), I can only imagine how incredible the technology is so when Barton "models" the budget with or without PCD, it makes me cringe whether he can even get that right. Anyway, being a technology company and investing in one is difficult but is even more difficult when management has done a poor job.

China Telecom Consolidation - I appreciated Hong Lu discussing this and giving his opinion. Lu mentioned that this has been a long, long time coming, is very complex, and chaotic. He mentioned China executives meeting every day because of the complexity and that there may be remorse from China Netcom for overpaying for China Unicom assets. Lu mentioned that there is a monopoly in fixed line (which the company is strong in) but that cable providers may get in the future. It would be costly for China Netcom/Unicom to convert PAS subscribers to CDMA subscribers. There are currently 84m PAS live subscribers compared to less than 30m CDMA subscribers. He anticipates losing 1/3 of PAS subscribers over time but operators will try to maintain the rest. There are current advantages to PAS on the data side and that China Unicom would probably use existing PAS base stations to promote data investments. The China Unicom side is more aggressive than the China Netcom side.

IPTV - This is the main core focus for the company going forward. Lu discussed that in Japan, it was hurt by regulations preventing iptv broadcast of terrestrial TV. If allowed, iptv would take off in Japan. In China, only 10 cities currently have iptv in some regulated form. In Shanghai alone, iptv is expanding by 40k/month or 500k/year. While it is now building, the explosion has not started yet. One executive commented that most people over estimate technology adoption in the next 2 years and under estimate the 10-year adoption. Just like NGN, iptv will have critical mass due to limited revenue generating capabilities on the less interacitve/less robust offerings. This is really the big hope for UTStarcom investors, that the significant revenue increase will come sooner rather than later (when other technology or other issues may overcome their advantage).

IPTV, NGN, Broadband - Brian Caskey defended the companies main core businesses. Capex growth from 2008-2012 for each is expected to be $16B, 17B, and 43B (or 19, 24, and 17%) respectively. The real question is how much can UT capture and what should they spend to get those revenues.

UT Business Units, financial models, and "targets" - Barton discussed financial numbers with and without PCD. Early projections for PCD was for a 4.5% revenue increase for 2008. Now, its up to almost 10%, from $1.664b in 2007 to initial 2008 estimate of $1.739b to now $1.825b. Margin is expected to be 6.9% and OPEX to be $40m. That is an operating profit of $86m. That alone probably makes up a significant reason for the stock run-up. The flip side is that the other core businesses are still nowhere close to management's stated target metrics. For the first time, we received information on the company's "core" business including $280m of UT products sold to the PCD. Early this year, initial guidance for core business (without PCD) was about $838m. Now, it is ($1.035b-$280m+$33m) about $790m. The first number is the stated 2008 "target" in the presentation for core revs, the $280m is the internally designed handsets, the $33m is an estimate of the MSBU. This may be totally off but it seems like some core revenue was delayed or pushed back to 2009. There was little core in the Q1 results so the rest of 2008 should still be ok. The larger picture is can the company make money without the PCD. There was a question on what the breakeven revenue if PCD was sold. By the end of the year, OPEX will be around $105m/quarter. Lets annualize this for 2009 so its $420m. If we take out $40m for PCD, then its $380m. Assuming an additional $5m in cost improvements/quarter in 2009, then you get down to $360m.

For $360m capex, you will need $1.33b and $1.2b for 27 and 30% GMs
For $380m capex, you will need $1.41b and $1.267b for 27 and 30% GMs
For $400m (including tax/stock comp), you will need $1.48b and $1.33b for 27 and 30% GMs.

Currently, they have only $1.035b in revenues w/out PCD (which include the $280m in internally designed handsets) with a overall GM of 27.2%.

Candidly, Peter Blackmore mentioned needing to improve sales by "several hundred million" and Barton hoping to target 5 to 10% GM more than OPEX so about 30 to 35%. But those could be 2+ years from now.

Revenues w/out PCD for 2008 will drop by 4% due to 16% drop in PAS and sale of none-core assets.

Revenues without PAS & PCD is projected to go up 10% this year and core infra bookings will go up 50% from 2007 to 2008. Barton cautioned that some of the bookings will be over a few years.

There is definitely a roadmap to satisfying the metrics Blackmore set up for SG&A and R&D but its hard to see it being achieved in 2009. Of course, those are without PCD, which this year alone is set to have $86m in operating profits.

There is probably some stuff I missed but the company is out of the woods (which the stock price has reflected) but nowhere near where longtime investors can be happy about. There is still significant value to unlock (see PCD) but operationally, not surprised that analysts are not upgrading or getting too excited about the company. The company has just finished changing/improving/or close to setting up their systems for ERP, CRM, BID and others. Blackmore is still pushing for improvements in the supply chain (need more scale and better forecasting for infra side; handset side has been outsourced).

Blackmore does seem to understand the bottom line although he is understandably enthused by the company's (and his own) situation (as I said, his timing is better than most investors :-). In terms of the shareprice, I have been pounding the table under $3 but not so much above $5 (obviously). The company needs to show more progress in divestitures, expense control, and revenue recognition before the next leg up. My end of the year targets still stand because I believe they can beat estimates and divestitures will be finalized by the end of the year (as Blackmore mentioned). I am in for the value but not necessarily the management/BOD. Credibility has to be earned and the good communication is a good start but operational performance is really the key. Asset/investment sales are "easy" ways to unlock value but to regain the lost shareholder wealth will take markets opening up and continued/sustained discipline and execution.

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