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.

Letter to management

This is a letter that I will be sending to management ahead of the shareholder meeting.

Dear Sirs,

I have been a shareholder for the better part of the last three years and have been very disappointed with the company/stock performance to say the least. The recent filings show the continued losses in 2006 and 2007 but more importantly, the street has lost confidence in the company due to their lack of communication during these critical times, poor internal controls, bloated expense structure, and lack of visibility in the company’s businesses. The continued losses into 2008 and history of over-promising and under-delivering has weighed on the stock.

It is very difficult to stay positive in light of the current sub $3 share price and know it will take some time to turn this around. I do have some hope with the recent actions from the company such as (1) finishing the options/China investigations-filing the financials for the last 5 quarters, (2) reclassifying and selling long term holdings in Gemdale/Infinera, (3) being able to transfer funds from China, (4) identifying core/non-core operations, (5) cutting operating expenses to $115m/quarter, (6) seeking out cash flow efficiency savings, (7) monetizing the patent portfolio, (8) showing tractions in iptv/broadband, gepon, optical, surveillance and other new initiatives and (9) hopes for profitability in late 2008/early 2009.

I have recently started a web-blog at http://utstarcom-stocknews.blogspot.com. So far, it has generated about 600 visits in just the last 12 days. The purpose of the blog is to compile information about the company, share investor opinions, and hopefully provide a conduit between shareholders and management. One of the reasons I am writing now is to discuss topics in the upcoming shareholder meeting. Because the stock price is at historic lows right now, shareholders have many questions on the company’s future turnaround plans as well as previous decisions and results. Let me emphasize that as much as we’d all like to move on towards the future, we need to learn from the past. With the stock being where it is, it is apparent that the street is also not moving into the future yet. Most stock price targets are in the $3.5 range and continued significant losses are expected in 2008.

A few topics that I have put on a poll (in the web-blog) that management can hopefully give more color to in the shareholder meeting are the following:

-Details of the strategic options study with Merrill Lynch. Shareholders are very dissatisfied with the explanations and lack of details surrounding such a critical event in the company. Where there offers to buy the company? At what price? If not, what where the major issues? What where the attractive points and negative points? We shareholders can appreciate that some information cannot be disclosed but I am also sure you understand where we shareholders are coming from in light of the shareprice.
-Gemdale/Infinera sale. Updates regarding liquidity are very important during these credit tough times.
-PCD divestiture. Most shareholders did not buy into the company with the PCD in mind and are mostly in favor of divesting the PCD to solidify liquidity position and focus on core businesses. I can appreciate that you cannot divulge too much but anything towards the divestiture of this division will help the shareprice. For me, this was the symbolic move away from core goals of the company and would represent a symbolic re-focusing the goals of the company.
-Japan revenues. Shareholders have not heard much regarding Japan and the close ties with Softbank.
-Convertible Bond update.
-Share repurchase or insider buying. The low share price has to be addressed by management. Projections are great but the street is looking for tangible actions by the company/management.

-OPEX and growth of the Core businesses. There are major concerns that the target opex to core revenue ratios that management has given in the last cc will not be met anytime soon (even in early 2009 and be sustainable) and that opex should be cut further now rather than later. Updates to bookings and future plans are much needed to clarify confusion with this important goal. Aside from 3rd party projections, what do you see in the iptv/broadband markets that give you confidence in attaining these ratios? Otherwise, this is another example of over-promising and under-delivering.

I would like to end by stating I appreciate the updates from the company and hope that it continues. The last conference call presented a very good start to addressing the street concerns but results are needed. Because the turnaround will not occur overnight, shareholders need answers to a lot of questions and management can do much more to defend the share price right now. I am personally looking forward to meeting management during the shareholder meeting next week and hope to get some answers to share in the web-blog to fellow shareholders.

IPTV in Korea/Vietnam-Next front for UTStarcom?

Thanks to Nawar for providing updates on Korea IPTV.

http://messages.finance.yahoo.com/Stocks_%28A_to_Z%29/Stocks_U/threadview?m=ts&bn=27187&tid=146476&mid=146476&tof=1&frt=2

http://malaysia.news.yahoo.com/rtrs/20071122/tbs-markets-korea-hot-b8dd11d.html

From the last CC,

"In particular the IPTV business continues to gain momentum. Attributively we have booked approximately 240 million in IPTV contracts and recognized approximately $80 million in revenue. We recently won new contracts in Fujian Province in China and a major new customer in another Asian country, which we can announce in a few weeks. We currently have IPTV deployments in China, Japan, India and Brazil. We have about half a million live IPTV subscribers and contracts for about 2 million subscriber system capacity.

We are not sure if Korea is the next deployment for UT. Some are speculating Vietnam but the growth of worldwide iptv acceptance is good for UT. The trends support explosive growth in iptv:

http://www.telecompaper.com/news/article.aspx?id=193418&nr=&type=&yr=

The bull case for longterm share price appreciation

Let me begin by saying that earnings the last 2 years have been bad and going to be bad in 2008 again. Just looking at the earnings estimates for 2008, analysts are expecting losses of $1.02/share. That is a frightening number when compared with the current stock price of $3.3. The street is waiting for the company to be profitable or at least be cash flow positive. Target prices are a fraction of book value. While this may seem reasonable and a reality of the current moment, this ignores the strategic position and assets the company has. For the past few months, I and others have added up liquid assets (cash, investments, and even the PCD) to size up the current situation and assess potential for a liquidity crisis that could negate any potential for a future turnaround. This was necessary because we did not have access to the financials, did not know whether the company was going to be sold/go private, did not know how quickly they would burn through cash, the impending convertible bond situation or the status of the current business itself.

Through the filing of 5 quarters of past results (Q3/Q4 of 2006, and Q1-Q3 of 2007) and update conference calls, I can say that I have never felt as confident about the turnaround as I have now. What turnaround am I talking about here? The share price going to $6, 10, 15, 20 or higher? No, the turnaround will be about discarding none-core assets, reducing bloated expenses and growing core revenues in the sectors and countries with explosive growth. Most of the long shareholders that bought 2 to 3 years ago had this in mind but circumstances and company mismanagement has moved away from this. Now, I can see the beginning of getting back to this situation/goal. Let me highlight some key developments recently:

-Separating the core and none-core business. The acquisition of the PCD division was the beginning of the downturn, moving away from their core goals/competency. It tried to cover up revenue loss from PAS and the company moved away from growth to a low margin company with losses and lost direction. Now, management has decided to realign the business units and separate the PCD division. Most shareholders have been talking about separating and selling the PCD for a long time now. On the last CC, Blackmore is basing target R&D and SG&A ratios to revenue that does not include the PCD. An analyst also asked about operating expenses for the PCD under the cover that the PCD is the largest revenue source for the company. However, this is really to value the PCD for sale in 2008, which even S&P concedes will probably happen.

-Growth drivers. Broadband and IPTV. UT current has 500k live subscribers and 2m system capacity. Current booked revenues are $240m, which only $80m has been recognized. These are not impressive numbers considering trials have been going on for years and the amount of R&D and other expenses they have incurred to acquire/develop the technology. However, the key take away is that commercial deployments have started and UT is the leader in very large markets. They have commercial deployments in Brazil (10,000 subscriber deployment now confirmed with Brazil Telecom), China (over 60% market share and 380k live subscribers-compared with 800k for PCCW-leader in HK, also was awarded sole provider for one province), India, and a new Asian country to be announced. UT is also providing the massive NGN/broadband infrastructure that needs to be built to support IPTV and other related products (65% market share in Korea, replacing old Siemens, Alcatel equipment in the Philippines, where other Asian telecoms are reviewing the deployments). The market is aware of this but is focusing on the “timing” when broadband/IPTV revs are going to hit. With the liquidity issue aside, I am more concern now about market share and start of deployments.

-Other technologies/drivers. Gepon, IP surveillance, FMC, new PAS technologies etc will provide future growth as well. Even with all the losses, the company is able to maintain R&D. There is a difference between a dying company burning cash and a company “choosing” to maintain R&D because they see the bookings and potential markets. This really is about the longer term growth and profitability so I agree with the steps taken now.

-China market. Almost every other company tries to get in China and increase revenue there. For the last 3 years, China revs have been declining and they are reducing head count and expenses. Since June, Lu has spent time there and have hired new management, improved controls/customer relationship and looking into the broadband market aside from iptv/pas. Aligning the PAS business back into core was smart to do. They cannot lose the relationship built up over the years. I am happy to see the company is refocused in China.

-Liquidity. This is a concern due to the current cash burn and CB due March 2008. The company was fortunate to have Gemdale and Infinera increased. Barton mentioned they have started monetizing Gemdale last week. They are able to transfer significant sums of money from China and have a target to reduce OPEX to $115-120m. At end of Q4, they still should have over $200m net cash and if they are able to extend the CB, would have half a billion to see this turnaround through.

The timing of the turnaround has always been questionable but this depends on the definition as well. For me, the turnaround has started and will be symbolized by the sale of the PCD division. Blackmore has targeted end of 2008/early 2009 to realize his target ratios. Previous discussions of profitability were not believable because there was no plan. Now, there are cost cuts and bookings to guide management.

The management has laid down a reasonable timeframe and benchmarks. Previously, I had lost hoped and wanted a sale. We are way past that point at this stage and prepared to wait it out. I think the strategy has a very good chance of working and the share price will appreciate significantly.