Commentary of Fran Barton (UTs CFO) - Overpaid or Underpaid

As many know, during the last shareholder meeting, I was able to meet and talk with Fran Barton, UTs chief financial officer, and Peter Blackmore, UTs COO and designated future CEO. A lot of people on the message boards think that because of this meeting with Mr. Barton and Mr. Blackmore, that I have suddenly been brainwashed and support all their decisions. While it was a good opportunity to meet with them and discuss certain issues, the final judgement on their performance is the stock price. On this post, I wanted to highlight my thoughts on Mr. Barton just because of the upcoming convertible bond and the fact that he has been with the company for over 2 years.

For those that have followed the message board for some time, they know I have singled out Fran Barton ever since he started and even made a comparisson to UTs former CFO, Mike Sophie. http://messages.finance.yahoo.com/Stocks_%28A_to_Z%29/Stocks_U/threadview?m=tm&bn=27187&tid=139373&mid=139373&tof=-1&rt=2&frt=2&off=1

People obviously don't have a good impression on any of the management based on the stock performance but Sophie was well versed with the company's operations and was even promoted to COO. But this is not a post to rehash problems with Sophie or even Barton but to discuss Mr. Barton's compensation and the critical resolution of the convertible bonds.

On top of Mr. Barton's pay in 2006, he received a "double bonus" for dealing with the internal investigations and now has a retention clause worth $10m over the next 4 years. There was even an earlier SEC filing that mentioned how important the key management to the success of the company. If you read the fine print on the bonuses, it is NOT tied to the company shareprice and the metrics are really very favorable to management (unfortunately for shareholders). It is very difficult for me or any shareholders to see the stock price near the all-time lows when their CFO is getting increasing salaries, yearly bonuses, and now retention bonuses. The "independent" compensation committee definitely is non-existent and I would love to be in management's position. Anyway, with that ugly background out of the way, Fran Barton can prove his worth to the company AND to the shareholders by resolving the convertible bonds in a way favorable to the shareholders (as he has mentioned plenty of times).

For 2007 alone, the stock price has dropped $6 or $720m in market cap. It is atleast $3 under book value with an enterprise/revenue ratio of 0.04. There are STILL over 30 million shares that are short. Even after being removed from the index where about 15 million shares exchanged hands, the number of shorts outstanding have remained very high at almost 30% of the outstanding shares. This is the immediate battleground that the shareholders are facing in the upcoming year. Barton does not have an easy job with the stock under $3 and they are in yet another "transition" period with the current credit environement and the expense intensive operations they are running. Nevertheless, they have adequate funds to pay off the entire loan or do a bridge loan for part of it. Selling part of the company by offering shares and diluting the current base is really unacceptable and not required. While the company has some cash requirements it has to maintain in China to satisfy Government requirements, they are nowhere near the financial institutions here that need to maintain triple A ratings and capital reserve requirements. Most of their $500m in cash over the last couple of years have been earning interest at 1.9%!

Going forward, the company will report financials for Q4 2007 and give their estimates for 2008. The outlook for 2008 will determine short term cash requirements and vitale for short term credit. This is where Barton's worth will be tested. He single handedly can resolve the CB issue by moving the timeline away to a much better credit situation. The shorts will not have the shares they are counting on to cover their positions. It will not dilute the current share price. On a side note, the other institutional longs that have gotten into redemption situation with owning UT should be in much better situations as well. It seems "obvious" to shareholders on what needs to be done.

Back to Fran Barton's compensation. Goldman Sachs CEO Lloyd Blankfein will get $68.5 m in bonuses while other CEOs will forgoe any bonuses. I would definitely like Mr. Barton's compensation tied to the shareprice but that is wishful thinking. Mr. Barton can prove his worth and more with the correct resolution of the convertible bond. We shareholders can talk about operational performance, iptv, window dressing, etc but the shareprice in 2008 is going to be driven to a large extent by the CB.

Mike Sophie raised a lot of money and did a lot of good for the company but that was during more favorable times. Fran Barton is faced with a much tougher scenario BUT a lower shareprice comes with much lower expectations and can be seen as a springboard to outsized gains. The next shareholder meeting with management will either be a major celebration or an even bigger train wreck. I hope I can tell Mr. Barton how underpaid he is and a job well done..........

UT continues IPTV momentum with win in Taiwan. BSNL in India next?

One day after closing at the all-time low share price, UT unveiled the Asian iptv customer that they discussed during the last cc. The deployment in Taiwan is as follows:

"The Markwell contract includes system capacity for 500,000 RollingStream IPTV subscribers and 20,000 set-top boxes initially. Markwell plans to deploy an additional 480,000 RollingStream set-top boxes over the next two years."

http://biz.yahoo.com/prnews/071220/aqth130.html?.v=25

Based on previous discussions on pricing, this contract may yield $20-30m for the intial system setup (hardware+software) and another $3m for the first 20k STB. Maintenance and other revenues for the STB will come later. It normally takes them 3 to 6 months to recognize revenue so it will probably be in Q3 2008.

The deployment in Brazil was for an initial 10k subscribers and system capacity of 50k more so this Taiwan deployment is much larger.

Another PR this week was the official launched of BSNL's multiplay broadband Internet services in India. This was positive because (1) it showed there was no major glitches in this large scale deployment which UT spearheaded, (2) the company can recognize broadband revenue, and (3) can anticipate more expansion contracts in broadband and iptv.

A fellow shareholder (Nawar) posted this on BSNLs launch of iptv on Jan 1, 2008

http://www.telegraphindia.com/1071219/asp/calcutta/story_8670469.asp

After the first IPTV win in India from MTNL early this year, UT had mentioned expecting two more wins in India which turned out to be Bharti and now probably BSNL. Reliance in India is working with Microsoft/Alcatel for their iptv but it would seem that it should cost much more with the half a billion contract with Microsoft alone. I am not sure how Reliance can recoup their costs on that venture.

After iptv deployments in Japan, China, India, Brazil, Taiwan, other possible areas could be Chile, Philippines, Pakistan, Korea, and Mexico? Previous articles mentioned trials in 40+ other areas. Also, if more licenses are issued in China or some "city" starts deployment, then the iptv revenue numbers will start to become significant.

All time closing low - letter to management

It is unfortunate to see the stock hit a new all-time closing low of $2.61 today. The market has been volatile and the year-end selling has pushed UT even lower. I sent an email to management to see if they would be willing to hold an update call or meet with shareholders. The company has done a much better job in communicating with shareholders the last few months but I am taking this "opportunity" now that the stock has hit another low to question management if there are plans to support/defend the stock if it goes any lower. Here is my letter:

Dear Sirs,

Today, the stock closed at $2.61, the lowest closing price in the history of the company and 12% lower compared to 3 weeks ago during the shareholder meeting. While I appreciate the efforts for turning the company around in the long term, I would like to know what (if any) plans does management have to defend the stock price in the short term if it goes lower. Is there any price point that you would consider low enough to prompt a response from management.

I know there are a lot of issues that you have to deal with in the short term such as (1) selling holdings (Gemdale/Infinera), (2) finalizing/implementing cost savings plan, (3) closing the quarter, (4) planning for the convertible bonds, (5) working on/negotiating future contracts, and others. However, the current share price is at a point that I believe deserves your attention, We could all wait for possible further share price deterioration but I think that is unfair to all shareholders and that your responsibility is also to address the share price as it goes lower. I understand your position for focusing on running the business but as I’ve mentioned before, the share price cannot be avoided. I would like to ask if you would be willing to schedule a conference call to update shareholders or to meet with shareholders in Alameda early next year.

Motorola, Palm, and UTs PCD

I was reading the Thursday edition (12/13/07) of the Wall Street Journal and came across a couple of articles regarding Motorola and Palm that were related to UT's PCD and the company in general.

UT has designated the personal communications division (PCD) as none-core and the consensus is this will be sold off/spun off in the future to generate cash and refocus the company to its core networking divisions. During the shareholder meeting, some shareholders asked Hong Lu why it even bought the PCD back in 2004. Hong gave a quick history and mentioned that UT was the biggest handset maker in China previously and that they could leverage the Audiovox division and their own division. A fellow shareholder Nawar has given a good historical perspective on the PCD performance the last few years: http://messages.finance.yahoo.com/Stocks_%28A_to_Z%29/Stocks_U/threadview?m=tm&bn=27187&tid=147623&mid=147657&tof=1&rt=2&frt=2&off=1

Anyway, how much can the company get for this division if it were to sell it? Here is a base reference from their 2004 purchase: http://utstarcom-stocknews.blogspot.com/2007/11/link-to-uts-audiovox-buy-in-jue-2004.html Based on rev/margin improvements, people are speculating that it could bring in $200-300m or more.

Here is where the Motorola article comes in. Carl Icahn has amassed a 3.3% holding in Motorola and wants to sell Motorola's handset division to release shareholder value (sound familiar :-). Based on Icahn's estimates, the handset division is being valued at $0 right now but should fetch one times yearly revenue of $20billion. Nokia is trading at about 2x yearly revenue. Analysts actually agree with Icahn but notes they have to fix certain problems before it can yield the desired value. The valuations (1x-2x revenue) are not applicable to UTs case because the majority of its handsets are resale/distribution and they don't have anywhere near the margins or brand recognition of Motorola or Nokia. In any case, the takeaway is even Motorola's handset division may be for sale.

There is also the confusion about UTs PCD because it has its own internally designed phones with higher margin and expenses plus the distribution part with higher rev/low expenses. Based on conversations with Barton/Blackmore, my impression is there is no immediate sale and that if any sales comes about, it will only be the distribution part. Let me say that this is just my feeling and I could be way off. Other knowledgable posters may shed more info if this makes sense or not. Anyway, even with the Motorola sale, there is the added problem of the current credit markets. The good thing for UT is that they are the smaller sized handset provider so it is more affordable and anyone that picks up the Motorola handset may just make a clean sweep to eliminate competition. Also, other smaller players that produce generic handsets can decide they only want UTs distribution portion.

What about the Palm article? Palm recently hired Apple's "podfather" Jon Rubinstein to revamp their own operations. Ruinstein has been on the job since July and has been putting in 70-hour weeks (Blackmore came in at the same time). I believe Palm is even in worse situation than UTStarcom. They have less share in their markets, as strong competition as any (heard of Apple and Research in Motion), and have declining revs/demand for their own products (their share of the smartphone market has gone down from 5.4% to 3.6% ouch!). It will also take them 18 months to develop new phones from scratch! UT on the other hand is incresing revs in India, iptv, and other lines of businesses.

One positive about Rubinstein is that 1 million of his stock options are tied to the company's stock hitting 50 to 200% above their grant date. This sounds good from a shareholder perspective but it didn't say how many OTHER options/shares/compensation he got. Anyway, both are turnaround stories but it seems to me UT has a larger chance to turn it around just based on their more diverse businesses, explosive growing and target markets. They have a larger expense ratio so there is that risk but that can be cut anytime as things change.

Another final take away is that other companies are not doing well also. This doesn't fully excuse management's performance but it is a tough environment that they have to navigate through. I feel UTs chances are very good for a turnaround given that they have been doing this for years now and have maintained or increasing their market share even now. A lot of UTs competitiors are also pulling back from certain markets while Nokia, Apple, and Research in Motion continue to assault Motorola and Palms markets. Anyway, its some consolation and things to think about.

The Convertible Bond - A Perspective

With the coming $275m convertible bond due in March 2008 and the stock languishing below $3, this has become a central point of discussion. The shorts are betting management is going to fall flat on its face and beg to refinace and resolve this issue by diluting and killing the stock. The longs are hoping the company's assets are sufficient to hammer a sufficient deal to avoid a large dilution and make good on their promise to think of the best interest of shareholders.

Back in late 2005, the company had a net $250m of debt but still had signficiant cash flows/backlog from PAS. The company took in $1b in Q4 2005 and began to accumulate cash, reduce debt and to be in position to pay off the rest of the convertible bond. In early 2006, quarterly results were still decent with minor losses. Lu decided to step down and the decision to sell the company was hatched up. We don't know the reasons for selling. Maybe it was due to the slow growth in their end markets. In any case, management spent time focusing on the exit strategy. At this stage, the convertible bond was still almost 2 years away. The acquirer would obviously be on the hook to deal with this and $275m may be "small" to them.

At the end of 2006, the company had amassed a NET cash position of $300m. That seems almost incredible compared to the current market cap of just over $300m. With PAS/Japan revenues falling dramatically now and still little improvements from iptv/broadband, the company started losing signficant amounts. Then, there was the added interest and costs to the investigations. To be fair, the company bought some PCD inventory, paid off suppliers early for discounts, and had some writedowns (hopefully for future contract wins), etc. We found out in July that the cash balance was now down to net $150m and continued losses would mount (we had thought the company would be profitable sometime in 2007).

At about this time, the surprising increase in Gemdale/Infinera holdings brought a windfall of over $100m. This was significant as they could use this to pay some of the debt off and have better leverage for refinancing. The problem was the stock was close to $3 and funds started having their own problems and the liquidity in the market was drying up. Now, things are looking a little better with the rate cuts, the company's own cost cuts/better cash flows. So, things change all the time but there is no doubt that it is much harder to refinance/raise cash with the stock under $3 (as Barton mentioned during our conversation). Nevertheless, I don't think the company has been negligent with the bond debt. It just happened that their main long term debt is coming due at precisely the worse credibt crunch for some time and with the operating performance of the company at all time lows. This is why we shareholders were banking on being profitable sometime on 2007 and hoping they would have cut costs much earlier.

The Gemdale/Infinera sale is a windfall that improves options. Obviously, this has to be discussed. Is the company in very bad shape. It depends on your perspective. I have often cited the worse conditions for the financial and other companies. Countrywide, Citicorp, Lennar, and even JetBlue had to sell assets to maintaintheir operations. Their outlook is even worse while UT performance is going to be much better. Another example is Hoku which is getting over $500m in financing to build a plant and won't be delivering any products until 2009! Financing is the lifeblood of a lot of companies. You can be the stock won't be at $2 and change if the debt was not due in March.

Management has said all options are on the table but with their assets/liquidity, management, S&P and other analysts do not see a liquidity crisis. What remains is uncertainty and how this will play out. Today's JetBlue announcement brought an initial 25% gain. Others (Citicorp, Etrade, Lennar, Countrwide) have had mix reactions depending on the structure. In any case, my view is for a full turnaround and that is only through operational performance. Of course, I would rather see a much higher shareprice once the CB is resolved. We'll see how it plays out.

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.