Monday, June 30, 2008

UTs PCD performance and valuation

Recently, there has been negative news in the handset industry. Sony Ericsson warned of falling mobile phone demand that will result in just a breakeven quarter and also warned of shipping delays during the quarter. Palm followed by reporting a quarterly loss of $43.4m. Motorola and Huawei are trying to sell and divest their handset business.

I have posted a few times regarding UTs Personal Communication Division. As we know, this has been classified as "none-core" and may be divested as well. Because of the significant profits/revenue that this brings to the company, some investors are concern that UTs PCD is going to be impacted as well. Lets look at the recent performance at Palm and from UTStarcom.

Palm Q4 performance - Total revenue was $296.2m compared to $401m from the year earlier quarter. The company lost $42m from a $17m profit. Smartphone sell through was 968k units, up 29% due to the Centro but its higher margin Treo line is slowing. Analysts expect the centro to peak in a couple of quarters and then Palm will really be in trouble. Gross margins are down to 25.3% and ASP for the smartphones (which make up the bulk of Palm sales) is down to $288.

UTs PCD Q1 performance - Total revenue was $431m, up from $288m in the same quarter in 2007. Gross margins increased from 5.8 to 7.6%. ASPs increased significantly to $209 and the company shipped 2 million units. Guidance for next quarter is $460-480m or sequential increase of about 9%. Book-to-bill actually went up to 1.3 from 1.2 despite the already 50% increase in revenue (amazing). Days sales outstanding (DSO) was down to 19 from 42 days.

Valuation - After dropping 18% in the last 2 days, Palm is still valued at $578m with an even higher enterprise value (due to its negative net cash of $120m). So, the enterprise value is closer to $700m even with the 18% drop. UT is projected to make over $1.8b in revenues and operating profits of $85m. What is UT's PCD worth?

Commentary - UTStarcom has designated the PCD as none-core and shareholders have been trying to put a valuation on it. Blackmore mentioned during the analyst day that they want to resolve their business unit lineup by the end of the year, so I believe all divestitures will happen within the next 6 months. While there are difficulties within the mobile phone space, the number of mobile phones is set to exceed 1 billion units with a 10% increase this year (this is not the automotive industry). Verizon's purchase of Alltel would also help UT. UT's lower ASP, lower gross margins and diversity in distributors are actually perfect in this environment as they take market share and act like the walmart of the cellphone space. In terms of valuation, it is still hard to put a number but could it be worth at least Palm's enterprise value of $700m? If so, that would exceed UTs current market cap [not including cash, building, and the core and (other non-core) businesses]. While the company has resolved a bunch of issues and there is improved bookings in the core businesses, I would attribute a good part of the stock run-up to the PCD business, which has been performing well. Based on its bookings, industry low returns (according to Blackmore in the last conference call), still low ASPs, it should continue to perform very well for the company.

PS. I added shares today partly because of the PCD valuation. I am still amazed the stock is at this level base on valuation alone. I'll post later in the week on valuation but I think you already see where I am going with this :-)

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