Since financial markets are incredibly efficient and since I cannot bring myself to fully research investment opportunities unless I have some real financial commitment, I’ve always subscribed to Soros’s maxim of: Invest First and Investigate Later.

Even though my gut instincts prove correct in many instances, in certain cases, such as that of UTSI, my intuition is misguided. In this post, I’ll highlight some additional information that I’ve recently uncovered that show that UTSI is not nearly as cheap as my initial thesis implied. Subscribers who have read my previous post should simply combine the information contained there with the clarifications in this post for a complete evaluation.

In terms of the balance sheet:
My initial post implied about $470 million in cash. However, in looking thru the latest conference call notes, the company estimates $100 million in cash outflow through the remainder of 2008. Taking into consideration certain cash in escrow, and other long-term investments, it’s probably best to estimate about $290 million in cash, as opposed to $470 million. This makes the company’s EV about $130 million, as opposed to -$50 million.

In terms of revenues:
In looking deeper at the company’s sales, I noticed that a significant portion of sales are generated from the company’s legacy Personal Access System (“PAS”) business. However, this business will slowly disappear. As noted in the company’s SEC filings:

“In 2008, we expect that new orders from PAS handsets and infrastructure will continue to decline due to the China telecommunication industry restructuring as well as increased pricing pressure. We expect our CDMA and TDSCDMA handsets will contribute more to our revenue and partially offset the decline of PAS business.”

Furthermore,

“We expect future PAS infrastructure spending to decline in 2008 as China prepares for 3G launch. We expect the decline in PAS infrastructure new orders will continue and we plan to aggressively pursue opportunities for our Packet PAS products (for broadband wireless data market based on PAS technology), dual mode enterprise PAS products and Softswitch products in multiple markets. However, we do not anticipate that these sales will fully offset the anticipated decline in PAS sales in 2008.”

Given my experience with a declining legacy businesses, such as experienced with ZILG, I’m inclined to assign zero value to the legacy PAS business. In addition, the company’s Broadband segment which generates about $100 million in a year in revenue has a mere 5% gross margin, implying that this business also has little value.

Overall, it’s not clear how much revenue is generated by new business ventures, nor what the odds of success is for new products. Even though management projects that new business will greatly offset the lost PAS revenue, there is no reason to trust their projections given their abysmal track record. A very conservative estimate is therefore that the new business is generating between $150 million to $200 million a year in revenue at a mid 30% gross margin.

Conclusion

If the numbers above are accurate than the current adjusted EV of $130 million implies an EV/Sales of a little less than 1 and at most an EV/Sales of 0.5. This is still cheap for this type of business, but not as cheap as originally supposed.

If UTSI is able to grow the new business revenue, such as from IPTV, then the current valuation will surely look ridiculous in hindsight. But, there is of yet no real proof that management can grow that business profitably, and as such the probability of an upside move in the stock is low. However, at the same time, it’s still difficult to see that much downside risk in the stock, considering the still large cash position and a potentially higher margin and growing revenue stream.

I’d still maintain that $3 seems about right on the downside over the next year, but that $5 is probably the most one can reasonably expect on the upside in the next twelve months, implying a fair value of about $4 for the time being. A 30% or so rise in the stock price is not that attractive for such a speculative name, so I’d recommend possibly waiting for a further dip in the stock price, possibly below $3, before initiating any position. Alternatively, one can probably wait for some financial evidence of a turnaround before buying the shares. In most instances, waiting for some financial proof of improvements in depressed stocks greatly reduces your risk, while not significantly decreasing your upside. This is because the stocks are so underfollowed by the investment community and the valuations are so depressed that it takes a significant amount of time before the shares reflect improved business prospects.