Saturday, July 26, 2008

Weekly recap - Break down or break out?

The stock closed lower for the week at $5.09, losing 9 cents or 1.7%. Oil continued lower this week ending at $123. However, the markets remained volatile and ended mixed with the DOW falling 1.09%, S&P losing 0.23% and the Nasdaq rallying 1.22%. While trading in Ut was limited to a narrow band and low volumes, the focus was on the symmetrical triangle converging to a vertex. I'll discuss this a little more at the end of the post but here are UT related news for the week.

UT debuts first iptv-based video advertising network in China - "UTStarcom will provide Guangxi Telecom with 3,600 concurrent IPTV streams for the initial deployment of the interactive advertising system in 14 Guangxi cities. In the first phase, set-top boxes will be deployed in supermarkets, department stores, office buildings and in Guangxi Telecom's facilities in Nanning, Liuzhou, Guiling, Qinzhou, Guigang, Wuzhou, Beihai and Baise." While revenues from the advertising systems and previously announced video surveilance wins will be small, it demonstrates the extent of iptv's functionality and potential usage/markets away from the home. Cisco, Nortel, and others have targetted markets such as tele-presence (setting up massive video conferencing rooms/networks). I see UTs expansion of iptv into different markets as similarly promoting iptv, broadband, and its ngn capabilities. The markets are small right now but the wins show that demand is there. The difference is UTs surveilance and advertising systems can easily explode as various cities in China implement it.

China internet users surpass the U.S. - "China said the number of Internet users in the country reached about 253 million last month, putting it ahead of the United States as the world’s biggest Internet market." "The new estimate represents only about 19 percent of China’s population, underscoring the potential for growth." The US and other countries have a 70% penetration rates. There were also discussions on the growth of internet advertising that should help UT in iptv/broadband areas. "With Internet use booming, so is Web advertising. The investment firm Morgan Stanley says online advertising in China is growing by 60 to 70 percent a year, and forecasts that by the end of this year, it could be a $1.7 billion market." It will be the Baidus that will benefit directly with UT benefitting indirectly with equipment/service sales. I like the following statement, "“The Internet market is the fastest-growing consumer market sector in China,” said Richard Ji, an Internet analyst at Morgan Stanley. “We are still far from saturation. So the next three to five years, we’re still going to see hyper-growth in this market.”

China operators statistics- From curious_tigre posting on the yahoo board, Thanks to Tigre for a very nice summary!

Brocade buys Foundry for $2.9b - Foundry makes hardward that competes with Cisco (routers, networking equipment, etc) with primary markets in North America. Foundry had about a billion in cash/investments so Brocade paid about $2b for the business. Lets look at the valuation that they paid. Foundry had revenue of $607m in 2007 (about 3x revenue), gross margins of 61%, expenses of about $282m and operating profits of about $100m (20x operating profits). Its not an apples to apples comparison between UT but it shows the market will pay for high gross margin businesses and operating profits. With UTs shares around $5, the UT business (about $1b in revenue) alone is being valued at 0 or negative at this stage. It would really surprise me with the current management focus on the core business and continued R&D/expenses that it cannot get the valuation higher than $0 or negative. The market will give UT time to execute their current focus (which they have done so) but at a certain point, shareholders will get frustrated and thats when pressure will build again for a full sale of the company. Lets hope that will be at much higher share prices and better positions than back in late 2006, their last venture of selling the company.

Worldwide IPTV and broadband growth- Aside from Tigre (which usually posts good information), Yahoo poster "Bamboozled" gets this week's contributor of the week for his various posts. It is interesting to note that Latin America, Middle East, and Africa are just starting and are UT targetted markets.

Iptv subscribers in various regions:

Region Q1 2007 Q1 2008
Europe 3,875,266 8,425,370
Asia Pacific 1,129,355 2,619,035
North America 850,601 2,258,601
South and East Asia 1,353,000 2,086,000
Latin America 2,300 11,183
Middle East & Africa 10,000 10,000
Total 7,220,522 15,410,189

Broadband growth for each region:

Region Q1 2007 Q1 2008 % growth
Western Europe 81,937,250 97,610,797 16.06%
North America 70,972,699 84,601,988 16.11%
South and East Asia 61,253,850 78,390,614 21.86%
Asia Pacific 53,310,214 59,017,122 9.67%
Latin America 14,867,952 20,154,134 29.3%
Eastern Europe 11,867,952 17,627,532 32.67%
Middle East & Africa 7,068,699 10,284,381 31.27%
Other 9,842 18,509 46.83%

"UTStarcom eyes growing iptv market in China"- "The prediction that IPTV in China is facing an opportunity, made three years ago, appears to be coming true.

According to one report of statistics from researchers Frost & Sulivan, the number of IPTV subscribers in the region is predicted to grow from the current 1.5 million to 27.4 million by 2013. Deployment will be strengthened by the explosion of broadband in various high-growth markets across the region, as well as through advancements in transmission, compression and watermarking technologies that have enabled more service providers to move toward IPTV delivery.

Short position and Naked short list - Short position increased again to 27.5m and there was a report of about 1.5m shares that have been failed to deliver.

Technical Analysis - While the stock has basically stayed in the $5 area for most of the last 7 weeks, the stock price is converging to the vertex of a symmetrical triangle. Traders have mentioned potential major break down or breakout of the stock price in the very near term. Something has to give. For the longer term, the stock should do well as the company has streamlined operations and are more focused. The technology and markets seem to be well positioned as well. However, there are always short term forces that could derail the stock such as continued losses, market weakness, etc. There is also the upcoming earnings announcement and pricing of employee options that may influence the stock price. I hope management stays positive and not purposely derail the stock for better options pricing. That would be sick but I've seen a lot of weird things in the market just this year alone so who knows. On the positive (optimistic) side, I am hoping management finally institute the long discussed stock buyback. As Barton mentioned, they would have to do something creative if they have excess cash :-) This is the time to do it guys............

Have a great weekend to everyone!

Saturday, July 19, 2008

Weekly recap - quiet on the UT front

The stock closed at $5.18, down 39 cents or 7% for the week. The stock traded from $5.06 to a high of $5.62. In the last six weeks during the market turmoil, UT has traded above $5 (except for a couple of days) and settled into a trading range. Most of the news was focused on oil pulling back from the highs and the financials/airlines roaring back. That led to weekly gains of 3.57, 1.95, and 1.71% for the DOW, Nasdaq and S&P respectively. The only UT PR this week was a follow up iptv contract with Aksh in India. Here are other news I happen to come across that may have some (little) bearing on UT.

Financials earnings reports - Merrill Lynch and other financial companies reported "earnings" that were pretty bad but the stocks rallied anyway. This could be due to short covering or the stock being beaten down too much. In any case, ML continues to raise funds through asset sales such as their 20% holding in Bloomberg ($4.4b) and interest in Financial Data Services company ($3.5b). Most of the attention was in financials due to their importance in the economy. Because we are in a bear market, investors that want to play turnarounds (like UT) have a lot of choices to make. Do you go with large companies that may take longer to turn around but have "less risk" of outright failure or do you go with a small cap like UTStarcom that has less of a history and "more risks" due to its smaller size?

Nokia's report - Nokia reported increasing its global market share to 40% and expect global device volumes to grow by 10% or more in 2008 from 2007. More importantly, they reported a 42% unit growth in phone sales in the quarter in the Asia-Pacific region compared to flat sales in Europe. UT still derives $280m or so in their handsets unit (not including PAS) so this is an important segment to keep an eye on. Also, the growth in broadband, iptv, ngn in the areas UT is targetting looks to be a sound strategy.

Yahoo-Microsoft-Icahn soap opera - Its amazing how much information comes out and concern for the shareholders that management/boards show when put in a situation. I was amazed previously that Yahoo management balked at the $33 offer and now is begging Microsoft to offer it again. The one major lesson for all management/boards is to listen to your shareholders (and not when its wayyyyyyyy too late that it becomes embarrassing :-)

Naked shorting - I'm fairly sure that UT was hurt with naked shorting and partially responsible for the stock price diving down to the $2/share range. However, with all the problems that UT had, the shorts were right. If management/shareholders feel the stock gets too low, then they should do something about it. In the end, performance is what counts.

Earnings wait - Here we go again. Usually, UT reports about a month and a half after the quarter closes, so that puts the next call around mid August. With all the automation and resources that companies put in their finance departments, you would think they could get this done much sooner. As an engineer(none-finance person) voicing out again, why does it take so long for the finance people to do their audits and file their paperwork when most of the numbers can be automated. Its funny when I see these "MBAs" or economists struggle in their business math classes (watered down versions of math classes) and yet they hold the money/decision making powers. Anyway, hope they can file it sooner and give some decent projections for the second half and how revenue will close the gap with the expense metrics they have been mentioning since last year.

Personal trading and dentist - I did well last week (if you are basically long and you didn't, I don't know what to say) specially since I am waiting for UT to pull back. There is still a large short interest in the stock so that is both worrisome and encouraging. So, in the words of fellow shareholder Gator, it will either break the 52 week high and go into the $6s or it will fall under $5 :-) As for my crown, the dentist had postponed the appointment until this week and only to put the "temporary" crown. I still have to go back in two weeks to get the permanent crown. By that time, I will have another cavity. he he.

Have a good weekend everyone!

Saturday, July 12, 2008

Weekly recap - stock rebound

The stock closed at $5.57, up 97 cents or 21% for the week, recouping all of last week's 95 cent loss and adding 2 cents for good measure. On the other hand, the markets continued to make new lows (S&P officially in a bear market) as oil's early week pullback was shortlived and new concerns in the financial markets (Fannie/Freddie) and technology (Cisco warning tech spending will comeback in 2009 instead of 2nd half 2008). All of this further highlights UTs outperformance. Aside from the closing of the PCD sale, there was no other UT official news release so I will discuss various pillars of strength for UTs stock outperformance.

Strong asset/balance sheet - Last weekend, I highlighted the cash and assets and it is around $5-6/share (taking into account the rest of the year's cash flows).

Execution - Primarily, this has been tied more to resolving past issues, strengthening the balance sheet (with asset sales) rather than operational turnaround to profitability. These included paying off the CB, settling SEC investigations, finishing internal investigations, catching up on the quarterly/yearly filings, etc.

Turnaround expectations - With most of the previous issues resolved and the balance sheet very strong, the company can now focus on its turnaround. Compared to other companies that have to worry about loans coming due (or raising funds/diluting shares), deteriorating macro environments (slowing economy, high oil prices, real estate falling, etc), UT can focus on its operations. The company is also one year into the tenure of Peter Blackmore (as opposed to other companies that are just switching - See Wachovia and others). The "turnaround" for UT has actually been going on for years (except that progress has been slow). At the "core" of this turnaround has been reducing expenses at the same time growing the core businesses significantly while offsetting the declines in PAS. Since Blackmore arrived a year ago, much work has been done to put the company in position for a return to profitability. With the asset sales, the company has put itself in position (and scrutiny) for this expected significant growth with Peter targetting growth of the core businesses by several hundred million dollars. Let us review the history and in essense the entire strategy that the new CEO has laid out for shareholders and to which he will be held responsible for.

This is what Peter mentioned last November at the Q3 2007 earnings call.

"We have cut the cost base in the functions against a benchmark goal measured by best in class in our industry and we did this against revenue reflecting our core technologies only. Not all the functions get to benchmark immediately as we do have internal controls to improve, new IT systems to implement and some legal costs as we close out this years investigations. They will all get to benchmark by end of 2008.

Although both our Research and Development, and SG&A percentages are currently too high, we believe we can do much better. The model for our R&D is between 10-11% of our revenue, excluding PCD. We believe this is a reasonable ratio for an infrastructure business. The SG&A model is between 13-14%, excluding PCD. Excluding PCD revenues is the right way of looking at our cost base, as PCD is a stand alone business. The SG&A is still too high, but there are a number of costs driving that, including, improving financial controls and implementing a new ERP system. We can get to the ratio as I stated by late 2008 and 2009. The revenues of the early part of 2008 are still ramping."

He added: “We shall see progress in 2008, but I want to make it clear that the revenue ramp in many of these contracts is deferred until implementation is complete, so the way to measure progress will be by bookings, plus a gradual growth in revenue and with it profitability.”

During all these times, Peter has not wavered on this repeating it time after time. The expense ratio goal is 25% of revenue and the overall GM target is around 30% for a net 5% profit.

Commentary (based on last weekend's assumptions of CSBU OPEX): If they sell CSBU, opex will be down to about $85m or $340m/year. If I use Peter's numbers of 25% of the revenue, then the revenue should be $1.36B. On my last blog post, I used the 30% (gross profit) to figure breakeven revenue, which would be $1.133B. Even the $1.133B would be about a 17% increase (plus the offset of PAS decline) so even that would be a $170m+ improvement over 2008 revenues. I suspect that not only is the backlog for the rest of 2008 heavy. The numbers in the Analyst Day meeting are very conservative and Q3/Q4 will be very good. However, for sustaining the metrics, 2009 should have a good ramp as well so that bookings for Q3, Q4 should also be very good. Q2 will only have $120-130m of non-pcd revenue (although with a 25% increase in Q1 bookings of 150m, that would already be a book to bill of 1.5+ although off a very low base).

Discussion with IR: I sent Barry Hutton, UTs new senior director of IR, an email to clarify the CSBU opex that Barton mentioned in the last earnings call and the discrepancy in the guidance. Rather than getting a quick email response, he asked me to call him and we ended up talking for 45 minutes. I don't know if other people have this experience but I just cannot get a quick straight answer from Barry. Its like talking to one of my new engineers right out of college that either doesn't know the answer, doesn't understand the question, is afraid to say he doesn't know, or acknowledge anything wrong or what. The guy kept on repeating that the current end of the year quarterly target is $95m and mentioning that the 10% discrepancy in the simple math guidance was not a concern (to him maybe). Anyway, the talk reminded me of having my teeth pulled. So, after wasting 45 minutes (I do enjoy talking about UT but that was like trying to get my 2.5 year old to do something!), we "agreed" that the opex would be $95m/quarter and he didn't want to get hopes up for anything lower. I tried to explain that the revenue target would be more aggressive with $95m/quarter! Anyway, we went through the math at $95m/quarter (just to see if he got what I was saying), and came to $380m for the yearly run rate. At 25% of revenue, the revenue back calculated would be $1.520B. Management definitely realizes the significant ramp that is needed in core revenues to hit Peter's target metrics.

As a shareholder, I am not worried about the current valuation (based on the assets, and recent execution performances) but still wonder about the aggressive revenue ramp target. If they get close to that in 2009 (sustainable), I am going to have to increase my stock price targets :-)

Personal trading - As stated last weekend, I had accumulated UT shares when the stock was collapsing the previous week. I did not get to my stated goal of doubling my holdings as it did not go lower. I did manage to buy all the way down from $5.5 (high) to $4.55 (my lowest). I did sell most of it at prices above $5 all the way to $5.6 (mainly because of this market). Let me clarify that I am keeping the core (obviously) but no reason not to add when the stock slides down or sell when you have a decent profit. I also bought a bunch of Nortel last week as the market is getting oversold. By the way, there were a bunch of posts discussing possible sale of UT due to its more streamlined company, better balance sheet, and most of the issues resolved. I definitely think it is much more desirable now than back in late 2006 (considering all the issues and lack of traction in their core markets). The potential suitors only wanted the core part and the fact that the company is pouring the majority of their resources into it (and selling the rest) leads me to believe that the core is worth something (amazing, huh ;-) Anyway, if a sale were to happen, it better have a huge premium or else it is so much better to see the company in the revenue ramp phase for once and see how high the stock can go.

Have a good rest of the weekend to everyone!

Sunday, July 6, 2008

Weekly recap - Stock pullback

The stock closed the shortened July 4th week at $4.6, down 95 cents or 17%. The week was highlighted by the sale of the Personal Communications Division (PCD). The markets continued to make new lows last week as oil made new highs nearing $150/barrel. News/highlights from the week include the following.

Divestiture of PCD - I covered the details in a previous blog post. In the larger picture, the divestiture means that profitability will be pushed back but liquidity improved significantly. Interestingly, this is one of the few cases that a $5+ stock gains $2/share in cash for a sale and then loses $1/share in the stock price. Overall, my feeling is that it is better that the company gets the sale out of the way now and can focus on sustainable profitability of the core businesses.

Cash generation - With the sale of the MSBU and the PCD, the company currently has over $400m in cash. Coupled with the cash position, UT will move forward the rest of the year with better Q3 and Q4 performances due to the backended core revenues being recognized. Also, it should generate cash from the cash (both from interest, receiving and not paying interest and even appreciation in the Yuan), ip patent licensing/sale (approximately $2m), and leasing the Hangzhou building. I also posted on the cash/asset base. CFO Fran Barton discussed previously that they should be able to do something "clever" with excess cash" if they have excess cash. We'll see.

Operating Expense (OPEX) - I posted a spreadsheet showing the historical opex ratios for the company and estimated ratios for the remaining quarters in 2008. In the last couple of years, I used 35 and 36% for the internal PCD revenues. These were unit volumes but I did not have dollar amounts. In any case, it shows that Blackmore's target metrics are still a ways off in yearly terms. Certain quarters like the upcoming Q3 and Q4 will be much better but it is not an indication of a trend because of the backended nature of the core revenue recognition. One thing that you cannot see from the raw figures is that the allocation of expenses is more focused as the non-core businesses are divested and "legacy" costs are being phased out. The core revenues are STILL declining which is not encouraging but bookings are turning around signficantly as well as the strategic wins we are seeing. The company discussed doubling their bets on fewer areas, which now has credibility due to the asset sales/strategic wins. Finally, the last major non-core business to be potentially divested is the Customs Solutions Business Unit (CSBU). From the last earnings call, Barton discussed OPEX on various non-core businesses. Here is a quote: "PCD varies around G&A of around let’s call it, $10 million a quarter. If that went that way that’s a number. If we looked at the IPCDMA business, I think it’s around $6 million or so per quarter. If we went that way, the custom’s business unit is probably, I don’t know, another $10 million a quarter or something like that. So those ranges, $6 to $10 for three different business units that are currently designated as non-core." Reading that again last night surprised me as I thought that business unit had revenues of only about $40m/year but was set to be profitable. I will try to clarify that from IR but it seems like signficiant expenses for that unit. Barton mentioned that by Q4, expenses should be under $110m (maybe in Q3 but surely in Q4 is how he has been phrasing it). Anyway, if you subtract the expenses from the MSBU, PCD, and CSBU, that could be under $85m/quarter? We will hear about the revenue ramp later this year but OPEX is definitely coming down (from about $135m/quarter) and liquidity is definitely fantastic.

GEPON - Shadowdoc99 posted on the growth of fibre in China (in particular). During the last year, Hong Lu has been in China stabilizing the situation with Wu's departure and drumming up business for broadband in particular. The latest update in the last earnings call from Lu: "Moving on to broadband, we’re very pleased to be beating and are breaking through in our GEPON business in China. For example, we’re working with the China Telecom for GEPON contracts in the Jiangsu, Zhejiang, and Fujian provinces. We’re also looking at the expansion contract with the China Telecom for gigabit EPON in Ningxia Province and are planning the trial with the Hunan Province and Jiangxi Province. With China Netcom, we are expanding our GEPON business in the Heilongjiang, Shandong and Hunan provinces. We are pursuing enterprise opportunity for gigabit EPON and have won a small, but important contract with China’s State Administration of Radio, Film and TV in the Vinan Province."

Thanks to Shadow for highlighting broadband in China. For some reason, my thoughts on GEPON was still back at the March 17 meeting when UT was still in the bidding process. I wrote then "As far as the other news of UT being shut out or not in the top suppliers for a recent gepon contract in China, management mentioned UT working to be a 3rd or 4th supplier. These are not big contracts and are usually divided among about four suppliers." Based on Lu's Q1 update and recent news that Shadow provided, there is tangible progress for UTs broadband and GEPON in China. Its funny that we as shareholders got excited about UT back in 2005 when they got a 5k subscriber iptv win in Shanghai and now with actual wins in GEPON and millions of lines being installed in China, this is not even front and center anymore. Even though, UT market share will not be as big in GEPON as in IPTV, UT will definitely gets it share of GEPON contracts due to its technology and the carriers wanting to diversify and give parts to various suppliers. Hong Lu again commented on the shareholder meeting that bottom line, fixed line carriers in China and worldwide are under siege with ARPUs going down and need to spend money to increase it.

BSNL iptv - I had a couple of back and forth posts with Shadow on whether the 4 India iptv wins included BSNL. I was fairly sure it did not because we had discussed it with management atleast on the March 17 meeting but I was concern since BSNL had been trialing and having various soft launches of iptv without UT officially announcing a contract win. So, this was one of my questions in the shareholder meeting. David King pointed out that they are working with Aksh as we know and that BSNL is working with Aksh. Here is a link that Shadow has provided.
I think its safe to assume that UT will win atleast part (if not all) of BSNL iptv going forward. The iptv ramp in India is definitely slow right now but strategically, UT has probably won 5 of 6 (Caskey mentioned another India win-probably BSNL was coming) and very well positioned to cross selling broadband, iptv, and ngn in India (which the company has pointed out many times). We should get news about this and maybe Hong Kong in the coming weeks/months.

BWS note - After the Analyst Day meeting, here was a note from BWS...

Q2 Earnings - During the call on the PCD sale, Barton mentioned the earnings call to be in a couple of weeks and Blackmore mentioned at the end of the month. That would be "early" compared to the previous earnings call from the past year. In any case, it is also interesting that some new analysts (one from GS) were calling in. Upcoming roadshows in the second half of this year show that UT management wants to tell their story.

I'll end the series of postings this July 4th weekend by looking back at the last year. Last year at this time, the company had just mentioned that nothing has resulted from the strategic study, they had fired Ying Wu, had just hired a new CEO, Lu had to go to China basically to stabilize the situation, had no timeframe for filing their delayed financials or results from the options investigations. Shareholders have yet to hear about the China investigations, more interest payments, and net cash dropping to $150m. The company would also be in the midst of about 6 quarters of burning $40-50m per quarter. The stock price then was $5-6. Fast forward to today. The company is one year in their turnaround, Blackmore has transitioned to the CEO spot, CB has been paid with no dilution, headcount has been slashed, SEC/China investigations are complete, material weakness and DOJ issues almost complete, iptv wins are quite impressive, ngn/broadband bookings doing very well, multiple divestitures and about $450m net cash in place. Current stock price $4.6.

The big negatives are profitability has not occurred and PAS is still in decline. PAS is becoming smaller and smaller but it is still in decline. The good thing is that distractions are out of the way and management has basically put growth front and center (while still cutting expenses and improving margins). Everything considered, the company is in a MUCH better position now. The stock may continue to go down (who knows in this crazy market) but I am just a little bullish this last week and going forward :-)

Have a good rest of the weekend to everyone.

Saturday, July 5, 2008

Life without the PCD - Focus on Growth

Immediately after the PCD divestiture, discussion turned to the core businesses and profitability. There were two posts by fellow shareholders that summarizes the situation.

"So, excluding numbers from the distribution part of PCD which is what UTSI just got rid of, UTSI will have an annual run rate of $282m in gross profit and $380m in OPEX. Thus to break even on operating income going forward, excluding any unforseen one-time charges, UTSI will have to boost high margin core revenue by $330m (at 30% GM), while keeping OPEX flat." writes Curious_Tigre.

The other post by Shadowdoc99 outlines delayed revenue recognition and strong bookings to make a case for profitability in 2009 despite the several hundred in revenues that need to be added (including effect of additional PAS decline).

Interestingly enough during the Q&A portion of the shareholder meeting, one of the questions I asked was the discrepancy of management's stance of getting the cost base right by early 2009 (or late 2008) and the revenue ramp that is needed to get the expense ratios low enough. To recap, management has targetted OPEX to be about 25% of core revenues (w/out the distribution part of the PCD). These metrics have not been met since 2004. Since then, the expense ratio has been way up and will actually peak this quarter (Q2 2008) at about 67%! See the table on expense ratios I have prepared on the side of the blog.

OPEX - Management's stance is that R&D has to be protected. In fact, they claim this is close to benchmark. While this is the case, much of the expense is actually in SG&A, where it is nowhere close to benchmark yet. Management has acknowledged this and it will drop significantly in the 2nd half of the year. They cite legacy finance, accounting, and legal costs to be reduced, adding that even the remaining Justice Department investigation will be resolved in the months to come (that was in the last earnings cc). Despite the OPEX cuts through the end of the year and continuing in 2009, it will not be enough to get to profitability.

Revenue Growth - Management is focusing on revenue growth to get the cost base right and return the company to profitability. Core revenue has been declining for years and even in 2008, will decline about 4-6%. So, why is management going on road shows, not cutting expenses more, and confident about the revenue growth? Confident enough to sell the PCD. I will point out some information (some facts, some anecdotal, some personal views, etc) that support the revenue growth.

  • Management's committment to the core businesses - Now that the management is divesting non-core businesses, there is no reason to believe they would not sell/divest of the remaining businesses if they don't believe they can be profitable and that the markets are huge. When the company looked at strategic options in 2006/2007, they had offers for parts of the company but presumably those were only for the valuable parts that currently make up the iptv, ngn, and broadband business.
  • Bookings - 50% growth on the non-pas; non-pcd business. Blackmore adds, “Our view is that these two product areas, NGN and IPTV are at the beginning of their life cycles and bookings can ramp fast. We are very pleased with the momentum they are gaining in their respective markets and believe the revenue for each of these product lines can grow in excess of 80% in 2008.”
  • Synergies - Selling iptv, ngn, and broadband are complementary. The strategic wins in 2007/2008 will lead to more wins/higher GMs and repeat customers. David King during the shareholder meeting discussed nurturing the 20 or so larger carriers/customers that they currently have.
  • New technologies - Blackmore has compared UT to a large startup. While a lot of the technologies were built over the last 5-7 years, a lot of the strategic/contract wins have only happened starting in 2007. The NGN wins in particular have come in bunches. From the latest IPTV news magazine ( ), FastWeb of Italy is spending 2 Billion Euros over the next 4 years to complete its NGN to deliver voice, data, and video over IP. We don’t know the size of the contract win with Tiscali (smaller than FastWeb and Telecom Italia) but the multiple wins (Philippines, Italy, Taiwan, Brasil, Thailand, and Argentina) does show significant activity in a very short time frame. (BTW from the shareholder meeting, the Tiscali wins were in the range of $10m and $15m for the two contracts last year)
  • Emering markets - It would be hard to see revenue growth in North America or some of the mature technology markets. Technology spending in those markets are going to be tough but not in the high growth markets UT is in. During the shareholder meeting, David King provided some color in Russia, discussing potential multiple wins by the end of the year. As I posted before, There was also the hiring of former Alcatel-Lucent executive Diego Martinez. "Based in UTStarcom's regional headquarters in Sunrise, Florida, Martinez will lead the company's sales efforts in Central America, Latin America (CALA) and North America while overseeing an extensive team of sales, engineering and support professionals in more than 30 countries."
  • Revenue recognition - As I mentioned in my post yesterday, there is a discrepancy of $83m in non-pcd revenues at the beginning of the year and the one presented by Barton during the Analyst Day Meeting. Barton explained the decline by saying PAS is declining 16% from last year. However, I think this was already built-in. More than likely, Barton is being conservative on the numbers and revenue recognition (as they have been for the last 6 months or so).
  • Confidence - So, when I asked about the several hundred in revenue that is needed to bridge the gap to profitability, Blackmore replied confidently that several hundred million was not that much and they will update the investment community in future earnings calls.
  • Focus - During the shareholder meeting, there were also discussions on various technologies and countries. David King admitted there was a lack of focus and "too much" technologies previously. Too much that even the marketing people didn't effectively capitalize on. The technology was just ahead of the sales/marketing. King discussed slashing certin divisions (one from 49 to 17 people for example).

Doubling their bets - The company is focused on iptv, ngn, and broadband. So much so that they are doubling their investments in these technologies. The question of profitability is far from settled and the cost base is still too high. I discussed with another shareholder whether doubling their bets at this stage was the right thing in today's markets. Basically, we came to the same conclussion. During good times, its better to be diversified. In uncertain times, its better to be focused. Just like in the stock markets, you don't want to be in UT when they were struggling during the bull market. But in a bear market, you want to be concentrated in good performers, avoiding bad performers or company's where the turnaround is far away or too uncertain. Just like UT doubling their bets on their core businesses, I have decided to double my position in UT. I have not bought all as the markets can be volatile (as we've seen last week, UT is not immune). However, I have seen enough during the last 4 years that UT strategy now is correct, they have enough wins to convince me it is working and will work in the future, and finally the strong balance sheet/asset base puts a floor and future exit point should the "growth" not materialize. The stock price at these levels still present one of the best (if not the best) risk/reward ratios for the company at any time of its history.

Friday, July 4, 2008

Metrics after the PCD sale

The initial guidance for overall 2008 revenues was for an increase of 4.5% from 2.467b to 2.577b. From the Analyst Day slides, 2008 revenues are projected at 2.580b. No problem there or is there? Barton gave a business unit breakdown of expected revenues (I'm using midpt range values) and gross margins as follows:

MCBU $315m 37%
BBBU $180m 24%
TBU $210m 22%
CSBU $40m 70%
PCD $1739m 6.2%
Services $60m 35%
MSBU $33m 70% (The last one Barton forgot to mention in the target but consistent with overall guidance)
That adds up to $2.577b and 15% GMs total, which is the same as the overall numbers of a 4.5% growth in revenue and 15% GMs. In the Analyst Day slides, the numbers were for a 4.6% growth and 15% GMs).

Here is the discrepancy. Because of the strong performance by PCD, the figure in the Analyst Day slides show PCD at $1825m or a 9.7% gain rather than a 4.5% gain. Great, right? Maybe. Non-PCD revenue was projected at $755m ($1035m - $280m internal design) for a decrease of 4.3% from 2007 (thats according to the slide note). However, in 2007, I calculated Non-PCD revenue of $803m ($2.467b-1.664b). Based on the business unit target breakdown, I calculated a 2008 Non-PCD revenue of $838m! If we go with the 4.3% decrease in Non-PCD revenue (as noted in the slide), then the Non-PCD revenue should be $768m and not $755m.

IF somebody made a mistake on the slides and instead of a decrease of 4.3%, it was an increase of 4.3%, then it would be $837.5m ($803m * 1.043) or in line with the Non-PCD guidance from Barton when he discussed the individual business units. If Non-PCD revenue is $755m, then that would be a decrease of almost 6% and not 4.3%.

Q2 guidance - Revenue of $580-610m and overall GMs of 14% were provided for a gross profit of $83.3m. PCD revenue of $460-480m and PCD GMs of 6.5% were provided for a gross profit of $30.5m. Non-PCD revenue of $120-130m and GMs of 36% were provided for a gross profit of $45m. Does $30.5m + 45m add up to $83.3m? I don't know about UT's accounting systems but it sure does not look encouraging.

Q3 & Q4 2008 - Q1 Non-PCD booked was $155.3m ($586m total rev - $430.7m PCD rev). Q2 projection is for $120-130m (say $125m). So, the first half will have Non-PCD rev of only $280.3m. Nothing wrong with that and Barton could be very low balling Q2. IF 2008 Non-PCD rev is $755m, then the 2nd half should still have $474.7m of Non-PCD rev (I really need to have an accronym like NP for Non-PCD :-). Anyway, at 33% GMs, that would yield $156.6 in gross profits for the 2nd half or $78m/quarter. If the 2008 NP rev was $838m, then there would still be $557m. At 33% GMs, that would yield $184m in gross profits or $92m/quarter. Of course, I still need to back out MSBU but say quarterly OPEX was still $100m/quarter for comparisson. Then, you still have to add the gross profits from the internal part of the PCD. This gets a little complicated because if it is only $280m of the $1.825b, then its 15.5% of the total but 25% of the PCD revenue in Q1 was internal UT made. So, if 25% of the $430.7m (or $107m) is gone, there is only $172m ($280m-$107m) left or $57m/quarter. At 12% GMs, that is still $7m in quarterly gross profits.

Ok, back to the 2nd half quarters, IF NP was only $755m for the year (still including MSBU here), Q3 & Q4 would have gross profits of $78m+7m = $85m with a $100m expense or loss of $15m. If yearly NP was indeed $838m, then Q3 & Q4 would average $92m+7m = $99m or close to the $100m expense. In either case, you can see that the second half should have strong NP revenues and hence the neutral cash flows for the year.

Now, I was going to do a 2009 evaluation using $755m NP as a base case and add revenue increases to see how much cash burn the company would have in various scenarios but I'll pause for now (the discrepancy is huge on whether the slide note and numbers were a mistake!). Something to think about......

Cash and Asset Position

After the PCD sale and subsequent 17% drop in the stock this week, investors are understandably not happy. Because the operations are not going to be profitable anytime soon, it is now prudent to look (again) at the (1) company cash/assets and (2) growth prospects of the core businesses and timing of profitability. I will discuss the first part in this post and the second part in another post.

At the end of 2007, the company had $503m in cash and short term investments. It also had $323m in short term debt for a net cash position of $180m. During the Q4 2007 call, Barton updated the cash at $220m and the debt at $40m (net cash of $180m with half of the cash in China and half in the US). The full year forecast prior to the divestitures of the PCD and MSBU was for neutral cash flows. The almost $100m net cash gain after Q1 2008 will be reversed in Q2. So, I will use the net $180m cash as basis for my year end cash/asset balance. Here are my estimates.

$230m (sale of PCD including $216m upfront and $14m in escrow to be received soon)
-$30m The PCD had operating profits of $86m. Lets assume this is all cash flow to the company. For the 2nd half of the year, I am assuming they will lose $30m more in cash flow. This assumes 12% gross margins for the internal handset and 6% for the distribution part of the PCD (also using 6.9% overall GMs, $280m in internal PCD and the rest about $1.545b for distribution part).
+0m (With the same argument, the sale of money losing MSBU should benefit cash flows - unless revenue recognition in the 2nd half is much stronger, but I will assign zero for now)
+6m (With $230m in cash, the company should make 5% in half a year or atleast save in short term interest payments/borrowings)

So, at the end of the year, the company should have about $386m in net cash. Now, lets look at other potential cash/assets.

$10-15m? (Sale of MSBU. This division had sales of about $30m and potentially more from a source that contacted me. I didn't want to add any cash from this sale to the above figure just to be conservative).
$40-50m? (The other non-core asset is CSBU, which includes the 3com Commworks division it bought for $100m a few years ago. This division will be profitable this year, have revenues in the 40m (double from last year), and gross margins above 50%.
$15m (Long term investments)
$6m (2% remaining interest in PCD assuming $300m valuation)
$6m (Bank notes)
$30m (Restricted cash)
$10m (Remaining receivables from PCD sale in escrow due in 12 months)
$50m (Due 2.5 years from now if cummulative earnings from 2008-2010 are met, looking good so far)

Thats about $175m more in assets that could potentialy be realized.

Plant, property, and equipment are valued at about $210m (with the Hangzhou property/building alone assessed at $180m last year).

There are obviously other factors such as receivables, payables, inventory, intangibles, etc but the above adds to about $771m (or $200m more than the current market cap). Shareholder equity based on the last 10Q prior to the two divestitures was $661m (or about $90m higher than the current market cap).

The cash/asset part as detailed above is relatively straightforward. We have been doing these analyses for a while now. The more important analysis is the cash flow/profitability of the core businesses in 2009 and going forward. For a while now, the stock has been discounting the underlying assets due to losses and other issues. The stock has increased due to the elimination of certain issues and the divestiture of some assets but operational profitability is still far off. Barton was correct that it provides the company with more transparency and they can really focus on the core businesses. The outlook will change from the bookings they receive from quarter to quarter but I'll take a closer look at the situation in the next post.

Thursday, July 3, 2008

Sale of the PCD - 100th blog post

When I posted last Monday regarding the likelihood that the PCD would be sold within the next six months, I didn't expect it would be the next day :-) The much anticipated divestiture of the PCD happened last Tuesday (July 1) for approximately $240m to AIG Vantage Capital, a part of AIG investments. "In addition to the cash consideration, UTStarcom could also receive up to US$50 million based on a three-year earn out provision."

The initial reaction to the sale was negative with the stock dipping to the low $5s and then rebounding back that day. Was it a buy on the rumor and sell on the news? Was it profit taking after a good run in this bear market? Was it disappointment with the amount? I have written a lot about the PCD because it made up a signficant part of the company's revenue and the cash/liquidity it could bring to the company. Some of my recent posts regarding the potential value of the PCD:

1. "Most people have discussed a $200-250m conservative valuation for UTs PCD." (March 8, 2008)
2. "PCD - Hamed was upbeat about the PCD (internal/resale). He thinks the resale part can be sold for/worth about $250m." (April 23, 2008)
3. "For the entire PCD, I am estimating it could be worth about $500m" (May 10, 2008)
4. "So, the enterprise value (PALM) 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? (June 30, 2008)

The company sold the distribution part only and maintained their internal handset design unit. There were 14 potential buyers and four offers. UTStarcom maintained a 2% ownership and a supplier agreement. Barton mentioned three benefits of the divestiture:

1. Releases high working capital requirements.
2. Cash proceeds improving net cash position.
3. More transparent company profile.

The company received $216m immediately and the rest in escrow ($14m for closing and $10m for product warranty to be released in 12 months).

If we compare the financial performance of the PCD with Palms entire company, it would seem that the price is "low" considering Palm's enterprise value is over $700m (it even went up today by almost 8%). However, in 2004, this division was only at a $800-900m yearly revenue run rate and margins were in the 2-3%.

Overall, the company is executing on their strategy of divesting non-core assets, cutting expenses, improving liquidity/cash flow, and focusing on the core businesses. I would have liked the company to receive more (just as in the gemdale, infinera sales - look where they are now though) but receiving cash in this environment is definitely a positive. Some will point to profitability being pushed back but the true value of the company will be whether the core businesses take off or not. The asset/investment sales give the company the time/position to focus on the core businesses. For that, as a shaerholder, I applaud the sale and congratulate management for executing the sale of the PCD at a very reasonable price and at the peak of performance to date.

On a side note, this is my 100th blog post (since the blog started 8 months ago). The sale of the PCD is symbolic for me in that the purchase back in 2004 represented a deviation from their higher margin/core businesses. As a shareholder, it was not what I invested in. So, this sale represents a refocused company that has been delivering on its stated goals and slowly but surely regaining shareholder confidence. Much more work is still needed (and acknowledged by maagement) to get to profitability (specially without the PCD) so it will be interesting on how management will navigate that and get to their stated metrics in 2009. In future posts this weekend, I'll touch upon the cash position and operating metrics of the company without the PCD.

Have a wonderful Fourth of July to everyone!