By Olga Kharif For the past decade, UTStarcom (UTSI) had seemed to defy gravity. While wireless gearmakers like Lucent (LU), Nortel (NT), and Ericsson (ERICY) suffered sliding revenues during the economic downturn, UTStarcom, which peddles a unique mobile technology sold mostly in China, managed to grow its sales from $368 million in 2000 to $1.96 billion last year. As an investor darling, its stock has recovered from the market's fall faster than that of other gearmakers.
But when things go wrong, favorites fall hard -- and that's what Alameda (Calif.)-based UTStarcom is finding out. After the market close on Aug. 10, the company announced it had asked the Securities & Exchange Commission for a five-day delay in its second-quarter filing. That's because the gearmaker is working out how to record a $1.9 million transaction that it had initially proposed recording as revenue in the second quarter, but decided later that it shouldn't be included in that quarter. The reason: it didn't meet the qualifications for recognition within the second quarter. Spooked by years of accounting scandals, investors sent shares down 14%, to $15.45, in early trading on Aug. 11. "There's a little bit of smoke, so perhaps people are concerned there would be fire," says Kevin Dede, an analyst with Merriman Curhan Ford in San Francisco.
QUESTIONABLE ACQUISITION? Still, that alone doesn't explain the Street's reaction. The accounting issue "is not an isolated item," says Lawrence Harris, an analyst with Oppenheimer & Co., which makes a market in UTStarcom's shares. Rather, it's just the latest in a series of the outfit's recent missteps, he says. That's the main reason its shares are down 67% from their 52-week high of $46.45 last August.
The Street first turned on UTStarcom when it announced, on June 14, its acquisition of Audiovox's (VOXX) cell-phone business for $165 million in cash. Partly because of its tiny market share, Audiovox has miniscule gross margins -- just 5%. UTStarcom, which hopes the acquisition will expand its presence in the market for a wireless technology called CDMA (Code Division Multiple Access), realizes it will need to revamp the new unit and pour lots of funds into its handset designs. And while UTStarcom hopes to bring the handset business' margins to 13% come next year, that time frame could be wishful thinking. In the meantime, the acquisition, expected to close later this year, could pressure UTStarcom's own margins, currently standing at 25.4% -- already down from prior periods.
The next blow came on July 27, when UTStarcom reported second-quarter earnings of 32 cents a share, on revenues of $689.6 million, which missed the Street's estimates by a penny. The company cited problems with a supply chain outside China. It also explained that it's facing a lot more competition in its main market of China, which generates the bulk of the outfit's sales. And UTStarcom said increased price competition pushed margins down to 25.4% in the quarter, vs. 33.9% in the year-ago quarter.
UNCERTAIN OUTLOOK. Together with China's cooling economy, these two factors have caused analysts to wonder if UTStarcom's execution, until then faultless, might be faltering. As a result, Reginald King, an analyst with W.R. Hambrecht in San Francisco, lowered his price target for the stock from $50 to $27 on July 9. After the earnings shocker, he lowered it further, to $17.
Indeed, while the stock may seem cheap, risks may outweigh the rewards. Michael Mahoney, portfolio manager at the EGM Capital hedge funds in San Francisco, says he wouldn't touch the stock until the accounting issues are cleared up. Even then, UTStarcom's growth prospects and margins outlook might remain too uncertain to warrant much of a rally, he says.
That's not to say that UTStarcom's bets won't pay off longer term. The gearmaker is still growing fast, with its second-quarter, year-over-year sales up 70%. It's working with consultancy Accenture (ACN) to improve its distribution, and it expects to report marked improvements by December, according to a company spokesperson. UTStarcom is also manufacturing more of its own components for phones. The move should cut the cost of its phones by $6 to $8 and improve margins, says the spokesperson.
Still, UTStarcom will have its hands full sorting out all these issues in the coming months. With an accounting problem thrown into the mix -- and its rivals on the rebound -- investors might want to consider looking elsewhere in this sector for now. Kharif is a writer for BusinessWeek Online in Portland, Ore.