Sunday, April 25, 2010

Pieces in place

Looking forward, does the company have the pieces in place to perform better, and lead to higher stock prices?

Cash - This is clearly a major strongpoint for the company. It has $267m at the end of 2009 with another $130m from the building and $48m from new investors. There are still significant restructuring payments to be made but the company should have around a net $400m going forward. Companies from Ciena, to Adobe to Microsoft have been raising cash for potential acquisitions (or funding acquisitions and repleneshing their cash positions). Because of UTs poor operational history and low stock price, it was vital for them to raise cash before asset prices (PCD/building) go down or the markets turn against them. UT has indicated it may do some small acquisitions in the internet gaming area but nothing large. The indicated use for UTs cash horde is to get additional loans and show the company's stability and using it to finance new business.

Management - The new management emphasize their Chinese backgrounds but they also have international experience (education/previous positions). Focusing on China is a priority but having international experience for their other markets is still very critical.

US listing - I think it is still important for UT to be listed in the US markets as their filings can be more trusted. It can also lead to further capital raising down the road as performance improves. The company has over a Billion dollars in losses that could be used by an acquirer in the future to offset future taxes as well. Century Tel's acquistion of Quest had a potential $1.7b in tax savings.

Outsourcing/Sale of the building - Besides the cash raised from the building sale, the oursourcing deal provides more flexibility to the company. The company can reduce headcount and focus on their core business of developing higher margin IP products (software mostly). Companies like Dell, Sony, etc are discarding high price manufacturing plants and going more into outsourcing.

Inventory - UTs inventory in the last quarter was down to $72.3m, down from $167m, $187m, and $161m the previous 3 quarters. Inventory has been an issue with UT in terms of writing down inventory and requiring higher working capital. The new outsourcing deal will also alleviate inventory issues (working capital freed up).

Margins - UTs decision to move away from handsets/smartphones will increase margins from the teens to the high 20s/30 range. This is still below industry averages (Huawei at 39+%). The company's iptv (software portion) already has very high margins as was evident from the MCBU's 50% GMs last quarter. It also generated about $40m in revenues from a software upgrade. PAS deferred revenue has about a 33% GMs (and low Phase 1/2 BSNL GMs) so UTs target of high 20s/30 GMs for 2010 is not relying on the deferred revenue to increase GMs but on new revenue having higher overall margins (from PTN and iptv). As the entire industry is focused on services and recurring revenues, it is good that UT's new focus on the cable iptv industry will be on financing the equipment and collecting fees/services revenue. This will provide higher margins as well as a more dedicated customer.

IPTV- During the Roth conference, UT reiterated their 44% market share in IPTV in China as well as projections for subscriber count to increase to 15m in China by 2011. While estimates have been way optimistic in the past, the Chinese government's push for triple play/convergence will definitely drive business the next few years. IPTV has always been the major hope for longterm shareholders as the potential markets in China, India, and elsewhere are projected to be huge and other sources of revenue (from broadband sales, advertising, gaming, education, software, etc) could become material as scale ramps up. We have seen a glimpse of the revenue/margins the company can have in Q4 based on the software upgrade for just over 1m subscribers. Let us not forget that the company's R&D has been focused on iptv for the most part of the last decade. It is still their most attractive asset for differentiation, getting high margins, and developing a loyal customer base.

PTN - With other broadband products that they have previously, this could have a very long cycle as it can also be used from the backoffice handling of 3G/4G wireless systems. I'm not an expert but this product should anchor the broadband business for years with higher than average margins.

Visibility - The visibility of UTs business has never been good. The backdrop of losing PAS business, relying on low margin handsets, having high opex and waiting for equipment sales has been a losing combination. The lowered expenses, inventory, outsourcing, control of financing, focus on iptv software, etc etc should improve visibility and allow the company to execute at a much higher level from the past.

Nothing is guaranteed and no guidance or tangible contracts have been provided but the above shows the company has been doing some signficant groundwork that will allow them to perform better. I am hopeful that their technology is still relevant and they are still in position to be a leader in certain segments/areas. Right now, I like their position but would like to hear more tangible news on progress from the starting points established above. I think they have a real opportunity to perform well and start regaining credbility from the street. There is always the chance of being acquired but I think they should really move forward and aggressively attack their market strengths right now (iptv-China, Softbank, India). Ciena, for example, has been aggressive and been rewarded. UT is now in a position to be on the offense. As a small company, they are disadvantaged from a longer term perspective but have certain niche advantage that they should use now. Shareholder value will be dictated in how quickly they can move now.

Institutional Interest/Short position - No signficant net movements on both front. Institutional holdings are around 50% while short position is in the 12m range. Volume has atleast moved from ridiculously low (300k/day) to above 1m lately. Both the institutional holdings can still increase significantly and the short position drop significantly. I think this will ultimately happen as the picture clarifies and shareholders will finally be rewarded.

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