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UTStarcom's Chinese Takeout

Light Reading
News Analysis
Light Reading
10/28/2004

A fast-growing and lucrative Chinese telecom market has been UTStarcom Inc.'s (Nasdaq: UTSI) bread and butter, fueling the company’s rapid growth and aggressive forecasting throughout the past two years (see UTStarcom Reports Big Profit and UTStarcom Posts Record Q1).

But the company's meteoric rise may be tapering off (see UTStar Cuts Estimates, Board Member Resigns and UTStarcom Accounts for Errors). Growing pains and competitive pressures now have analysts wondering how fast the vendor can win some significant deals in other countries.

Earlier this week, UTStarcom again reported a drop in quarterly earnings, which company officials blamed on shrinking margins in the Chinese market. It's not that UTStarcom's revenues in China are down. The problem is that cutthroat competition means UTStarcom keeps less money from each sale.

The company's third-quarter net sales were $645 million. That's 10 percent greater than the $584.4 million it reported last year -- and better than analysts’ consensus expectations of $591.5 million. It's noteworthy that UTStarcom had already adjusted its guidance downward on September 20 from between $695 and $700 million to between $590 and $600 million.

While its revenues were up, the company earned $5 million, or 4 cents a share, for the quarter ended September 30. That's down from $59.1 million, or 46 cents a share during the year-ago period. Analysts’ had predicted earnings of 3 cents per share for the quarter.

CFO Mike Sophie explained that downward pricing pressure and increased competition are eroding margins in its Chinese market, while the company works to develop higher-margin markets in Japan, North America, and Latin America. Company officials and analysts agree that UTStarcom's future is tied to developing markets outside China and the company is now challenged to survive those growing pains.

“There are two ways you can reduce your focus on China,” says analyst Joe Noel of Pacific Growth Equities Inc.. “You can grow in other places to the point where China’s percentage [of sales] goes down, or you can simply cut in half the business you are doing in that market; UTStarcom is doing a little of both.”

Noel believes that China can remain a strong source of revenue though 2005 while the company develops new markets. “China is not growing quickly now compared to the rapid growth of 2002 and 2003; but China has traveled a long way down the road with UTStarcom technology for three years now, and they can’t turn back now.”

Some, however, are concerned that UTStarcom's diversification isn't happening quickly enough.

“China was still 91 percent of the company’s business this quarter,” notes analyst Reginald King of W.R. Hambrecht & Co. “They say that number will go down to 50 percent in early 2005, and they told us it would begin changing in the second quarter, then in the September quarter, but we are still not seeing much progress in that direction."

King says the main objective of the company's most recent conference call was to reassure analysts that the company has good reason to remain confident about, and committed to, its 2005 earnings estimate of $4 billion in sales and between $2 and $2.20 in earnings per share.

“I know that we are going through a temporary period of volatility," said UTStarcom CEO Hong Lu on the call. “However I am not running the company for the success of just one or two quarters; I am focused on delivering long-term growth, profitability, and a dominant market position.”

— Mark Sullivan, special to Light Reading

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