Sigma Designs and growth of IPTV

Tonight, Mad Money's Jim Cramer picked Sigma Designs as his featured stock. Sigma Designs makes the chips that go into the iptv STB and Blue Ray players. Cramer highlighted yesterday's PR by AT&T and their plans to spend $4.5-5B in their U-verse program suggesting iptv is at the beginning of the growth phase and Sigma Design will be a major beneficiary. He mentioned a target price of $100. I posted yesterday about some of the iptv spending and the U-verse program in particular.

Obviously, I am writing about Sigma Designs because of its link to iptv and UtStarcom. Sigma Designs is a supplier of UtStarcom. Some have wondered why Sigma has such a high market cap compared to UT while having much smaller revenues. Here are some numbers. Sigma currently has a $1.7B market cap compared to UTs $327m market cap. Sigma's GMs are 50% compared to UTs 10-15% (UTs iptv GMs not including STB is over 40%). Sigma grew revs at 50% from last quarter and 164% from last year. UT revs are flat. And finally, Sigma makes $2.5/share while UT is losing $1-2/share/year.

While the financial metrics are like night and day, UT is progressing in iptv winning contracts in Japan, China, India, Brazil, and a yet to be named Asian country. GMs in UTs iptv (not including STB) is over 40% and subscriber growth (while "lumpy") is significant and has reached over 600k subscribers. UT is definitely in a position to benefit from iptv growth as well as Sigma Designs.

Sigma currently has a much better model in that it supplies other providers, has much less operating expenses, and very high overall GMs. While Sigma benefits from providing others, they will get major competition starting in January when Broadcom and others introduce their products. I believe UT's benefits will come later on as they established their foothold in various regions. Thats why its essential that UT get their footprint right now even and why I support current expenses. The critical battles are being waged now. Equipment are being tested and contracts are being awarded now.

I talked with Fran Barton and Peter Blackmore about Sigma Designs and their high market cap compared with UT. As shown above, there are major differences but there is no denying UT's main growth driver going forward will be iptv. What I tried to get at is the higher operational costs and the slow growth/margin of the other businesses. So, I was atleast content on sharing my views on discarding the PCD and other none-core business and lowering expenses when prudent to do so. I believe management knows this anyway but the key to higher shareprices is having the street appreciate the growth in iptv without it being diluted by other slow growth/low margin businesses and obviously the losses.

Unfortunately, UT is still known as a PAS company or a PCD company with huge losses and debt issues coming up. Its painful to see a company like Sigma doing so well when they are UTs supplier. Hopefully, the company will take necessary steps to get to profitability, focus the company on their core businesses and then the street will see the company for its positives. Maybe one day, UT will be mentioned by Cramer in a positive light after all these years. He has gone from hating the company (he doesn't trust those guys) to pitying it the last time saying how much it has hurt shareholders and alluding to all the potential and missteps.

The potential is still there. There is still time and UT has the technology and the market is at the very beginning. It is up to management to manage resources well to get the company back to its glory days of growth and profitability.

IPTV Spending

"AT&T expects to spend between $4.5 billion and $5 billion on U-verse through 2008. The deployment is expected to reduce 2008 earnings by 12 to 14 cents a share."

http://biz.yahoo.com/ap/071211/at_t_analysts.html

"Bharti would be investing Rs 150 crore in the initial phase."

http://timesofindia.indiatimes.com/Airtel_to_venture_into_IPTV_DTH/articleshow/2478365.cms

Here is the well known $500m Reliance-Microsoft pact...

http://www.foxnews.com/wires/2007Nov05/0,4670,IndiaRelianceMicrosoftTV,00.html


UT has won Bharti but probably not Reliance. The spending above definitely is not only for the iptv equipment but overall buildouts but the fact that amounts are huge shows the committment of suppliers and operators to iptv.

AT&T only has 126k subscribers at the end of Sept compared to UTs over 600k subscribers right now. AT&T is targetting 1 million by end of 2008. UT could have 2-3 million by end of 2008. The figure from Bharti is about $35 million for their "initial phase". We are not sure what this figure consists of or if this is for the 150k initial subscriber target. Reliance's $500m for the software is staggering. How can they recoup this? In any case, UT will get their share and the trend is growth in iptv will be huge. Also, if the iptv equipment by others do not work or do not scale, UT may have a shot at taking over. The high cost by other systems and the fact that UTs can scale and has been tested worldwide and been around shows this is very possible and would be a major development.

UT deploys in Brazil, 3rd leg of BRIC countries

Today, UT confirmed deployment in Brazil, one of the BRIC (Brazil, Russia, India, and China) countries that the talking heads usually discuss for growth opportunities.

http://biz.yahoo.com/prnews/071210/aqm095.html?.v=32

As with the other countries, it has taken time for actual deployments following tedious regulatory and trial phases.

Back in Aug. 8, 2005, UT provided equipment for a 2000 line system to Telemar.

http://sev.prnewswire.com/computer-electronics/20050808/NYM03908082005-1.html

On June 7 , 2005, UT and Cisco partnered in Brazil.

http://sev.prnewswire.com/computer-electronics/20050607/SFTU07107062005-1.html

The announced contract today was already hinted at from previous press clippings in Brazil (See iptv links).

Going forward, we hope to hear news about the Asian iptv customer that management has discussed in the last CC and during the shareholder meeting. From talking with Peter Blackmore, UT is just waiting until the customer gives approval to release the news. The current speculation is either Korea, Taiwan, or Vietnam.

While the stock stays stagnant, this news in Brazil is yet another data point for the long term turnaround for the company.

Oversold and the $3 mendoza line

There has been a lot of discussion regarding the book value and the discount the market is assigning to UTStarcom. Analysts have lowered price targest to the $3-3.5 range. S&P, which once had a sum of the parts valuation of $11 earlier this year now has a $3.5 target or about 60% of book value.

Explanations for the low price ranged from continued losses into 2008, lack of visibility, poor management, bad internal controls, bloated expenses, stiff competition, bad regulatory environments in their core iptv markets, low margins, shorts piling on, long funds having to force liquidate, lack of near-term catalysts, end of the year tax selling, greedy management, lack of BOD oversight, uncertainty in refinancing CB and short term loans, and others.

Facing all of this, the stock has dipped under the mendoza line and has become unmarginable further increasing selling pressure as margin traders have to liquidate or cannot buy using their holdings. This has made just keeping UT very expensive from the loss of buying power.

Anyway, just wanted to recap the share price history under $3. Despite all of the above selling pressures, UT has held the 52 week low back in August and have managed to sneak above the mendoza line ($3) for the most parts. A "trend" is starting to develop where the stock trades under $3 for about 6-8 days and then starts going up. These are the following dates and number of trading days under $3.

8/7-8/16 (8 days)
8/22-8/31 (8 days)
9/10-9/17 (6 days)
11/1-11/12 (8 days)
11/15- current (14 days)

The number of days show that it takes time for the margin players to get washed out and some time for longs to get confidence back and see if the lows will hold. I believe the stock is definitely in oversold territory even in the very short term (14 days under $3). The lack of news and low volume means the stock can continue to stay under $3 towards the end of the year but at some point will break above $3 and hopefully won't look back. What the data does say is don't go on margin but definitely buy under $3.

IPTV Revenue for hardware, software, and STB

This is a response to Tigre and Shadow's discussion regarding Unit costs for UTs IPTV system.

http://messages.finance.yahoo.com/Stocks_%28A_to_Z%29/Stocks_U/threadview?m=tm&bn=27187&tid=146545&mid=146686&tof=62&rt=2&frt=2&off=1&p=zg17j6DAWsehBrnpIXT_5T1OwDMyix.sVkMYZ92W97HQGtpKJqu0EBM-

Tigre concluded that per line hardware cost on the average is $15-20, $20-25 for software, and $80 for STB. From the Q&A session, we found out that per line cost is $10-30. I would assume this is for hardware and that STB is over $100. In addition, iptv GMs were 40-45% without STB and the STB was under 20%.

Just some rough estimates on the $240m in total iptv revenues that UT reported for 500k subscribers and 2m system capacity. Using $45 per line cost and $120 for the STB, I get the following:

2mil*$45 = $90m
$150m/$120 = 1.25m STB as part of the overall iptv revenue

Using 15% GMs for STB and 42.5% GMs for iptv hardware/software leads to

$150m(.15) + $90m(.425) = 60.75m in gross profits or 25% overall GMs.

Its in the overall ballpark of the GMs discussed all along. I'd like to commend Tigre and Shadown once again for bringing up an important topic and for zoning in on some proper numbers.

Recap of Q&A sessions from the shareholder meeting

Shareholder Meeting.

I attended the shareholder meeting today held at the Alameda corporate office. From management side, Hong Lu, Peter Blackmore and Fran Barton were the main speakers. Also in attendance were Susan Marsch (General Counsel), Thomas Toy (Director), other employees, and their auditors. Before I get into the details, I’d like to thank management for conducting a professional shareholder meeting, taking questions from shareholders during the Q&A portion and showing us their current line of products afterwards.

The initial part of the meeting dealt with administrative issues such as Thomas Toy’s nomination and confirmation as a Tier 1 director and reconfirming PriceWaterhouseCooper as their auditors. Then, Blackmore, Lu and Barton each took time to discuss the company business. I will skip their presentation for now as that is recorded and I can listen and summarize that at a later time. I want to move to the Q&A portion that was not accessible to the general public. The format for the Q&A portion was to have each shareholder have an opportunity to ask 1 question and if time permitted, additional questions would be taken. I think it was a good idea for them not to include this in the web-cast for the shareholder’s privacy and the unpredictability of the line of questioning and discussions. There were about 10 shareholders that attended, a few flying in from out of town and one from Mexico! There were no analysts present. I was working in San Francisco and took off from work in the afternoon to go across the Bay. I was concerned with the initial thought of the Q&A session being recorded because we may not have the opportunity to ask as many questions and again would be too unpredictable. That being said, I was also worried that frustrated shareholders would pull punches if it was recorded.

I’m pleased to report that the Q&A session was very candid, open, and sometimes heated starting with the initial question regarding the sale or lack of sale of Gemdale (only 10% has been sold). As you can imagine, each person had multiple questions and management did a good job in responding and moving it along. The questions included:

Why was only 10% of Gemdale holdings sold?
What is the average infra revenue per iptv subscriber deployment?
What are the available options to deal with the convertible bond?
Can you get financing in China?
Will they try to get financing in China or the US?
Why not cut costs further if most of the core technologies are already developed?
What were the details for the ML strategic study? Where there offers for the entire or part of the company?
Based on the current low share price and positive expectations by management for the future, would you consider share buybacks and/or insider purchases? (my question)
What valuation did the board have in mind (my follow up question to the ML discussion that I asked Mr. Toy– I got to ask two questions J and anything directly related to the stock price was applauded by the shareholders)
If iptv is positioned as the growth driver, why are the overall margins relatively low?
Can you clarify your opex to core revenue ratios and the potential core revenues in 2009?
Can you comment on the high short position?
Discussion on PAS revenues-packet data 128kbps (not sure if this was in the general discussion or Q&A)

After the formal Q&A session, they lead us to another room for a more informal one on one discussions and to show us their products. The group basically broke up into two separate groups of shareholders, one with Hong Lu and one with Fran Barton and Peter Blackmore. I spent my time with the 2nd group and had very open and candid discussions primarily with Fran Barton and a bit with Peter Blackmore. After the shareholder meeting, I met up with some of the other shareholders and discussed the meeting and compared notes for another half an hour or so. So, the entire event lasted a little over 3 hours for me. After the more formal Q&A session, the following items were discussed in the more informal session:

· PCD and its place within the company now and in the future
· OPEX- how it is currently bloated even with the planned cuts
· Lack of disclosure during the yearlong quiet period when financials were released
· Discussion on timing of the turnaround
· Why were the previous estimates from Barton so far off?
· Any updates on the recent BSNL tender for GEPON/WIMAX gear
· Info on the WiMax gear shown on their website. Potential market and position within their company in the future
· Updates on Japan revenue
· When will the new iptv Asian customer win be announced?
· Different handsets in the marketplace and if UT was involved with them
· Lu discussed the reasons for originally purchasing the PCD
· Lu discussed the iptv competitors and how their product compared to them
· Lu discussed his impression of the shorts. Someone asked Lu how they can break the shorts
· Lu discussed the impact of the Verizon’s decision on opening up their network
· Lu also discussed Japan ADSL and position of various operators in Japan
· Lu discussed their position as handset integrator for Verizon and others
· What are institutional reactions to the current share price?
· Selling or borrowing against the China building

There are probably more items discussed as I was only in one group and just heard part of Lu’s discussions with the other group.

So, what are my general takeaways from the shareholder meeting? The shareholders did not pull any punches making their frustrations, concerns, and suggestions known. To management’s credit they answered everyone’s questions and are well aware of all the shareholders concerns. Obviously, this was a very difficult environment with the stock price at $3. While I don’t agree with everything done in the past, I believe they are taking reasonable stapes at this stage to return the company to sustainable profitability. It’s a line and management position that we have heard plenty of times before (cutting costs, improving controls/efficiencies, waiting for market to grow, using partners, using OEMs, having great products, concern about shareholder value, etc). I had gone in thinking there was no good option at this juncture anyway so I would be in no matter what. Having talked with management, I have “hope’ that much better times are ahead and somehow things are different this time. Maybe, I’m a sucker for a happy ending. In the short term, not selling the Gemdale position may hurt the stock but it was going to be difficult to go against the bad stock technicals and at this late in the year anyway. The turnaround is not going to occur right away as we all know.

Some thoughts on Peter Blackmore, the future CEO of the company. I paid close attention during the Q&A portion and he was in agreement with the shareholder concerns and you could see him often nodding. I think he is very sharp, is the right person for getting the cost structure right and making UT very competitive on the cost side. I believe he understands the company assets and potential markets that UT has and can lead the company back to profitability and higher share prices. Obviously, this was a shareholder meeting and management has to be generally upbeat so we still need to track their progress and COMMITMENT to profitability.

As mentioned, I had more discussions with Fran Barton and thank him especially for his candidness and willing to engage the shareholders. As most know, I am not a techy like Tigre/Shadow so it was enjoyable to discuss the stock price, the way the street values UT, his previous and current estimates, etc. Ultimately, I hope they are able to better predict their business operations to make necessary changes to their cost basis and to better communicate with the street. Towards the end of the Q&A session, I specifically wanted to thank management for updating the shareholders and having all of those CC. I hope they continue and more importantly hope it will be under much better operational performances.

Zacks keeps sell rating and reduced price target to $3

Two days before the shareholder meeting and following S&Ps and BofAs $3.5 and $3 targets, Zacks reduces its 6-month price target to $3.

http://biz.yahoo.com/zacks/071127/10399.html?.v=1

The key reasons include:

1. Lack of business momentum and declining GMs.
2. Not expecting profits till 2010. Company financials do not reflect the anticipated synergies from the restructuring activities.
3. Possible default of convertibles.
4. No near term growth elements.

I agree with the near term profitability picture as losses of 41 and 28 cents are expected for Q4 and Q1 but I would disagree with the declining GMs (these are set to go up from 10 to 13% and improve in 2008), no profits till 2010, default on convertibles, and near term growth elements (need to check bookings and new wins). I do agree with the financials not reflecting the restructuring activities because these won't be felt until Q1.

Hopefully, the current low shareprice and reports like this will spur management to make significant structural changes and make tough choices that they have not done in the past. If so, then we can look at these months as the bottoming phase and look forward to the long-awaited turnaround.