Pace: The Potential Upside Story?

29th Jun '11 by AJ Sangha

5 comments 7580 reads

Pace Micro Technology (LON:PIC) has seen a spectacular fall from grace from its share price highs due to a combination of not meeting financial result expectations with the City and not being transparent enough about the problems causing these short falls. Pace has dropped from the circa 200p region since the start of the year to a 52 week low of 87p and currently trading at 107p.

A key action that would seem imperative for Pace to restore integrity and credibility with shareholders would be by firstly replacing the existing Chairman, i.e. the company's face that is a communication conduit with the shareholders of the firm (and secondly to consider changing key managers on the board).

Pace has now addressed the first by appointing the much respected Allan Leighton as the new Chairman for the company.

PRICE DISCOUNT

The current price of 107p is valuing Pace at a relative Mark-to-Market valuation, circa 50% discount to peers, making it a real target for takeover. The current valuation implies that Pace is in a distress situation, questioning it operating as a going concern. The reality of the matter is that Pace still has a leading International presence in the set-top box market. The current financial liquidity position is relatively healthy with £85m in cash levels, sufficient finance cost servicing cover – circa 10x cover, etc.

In a worst case scenario, if the pay-TV industry moved entirely to internet broadcasting, Pace’s market would still be worth 75p per share. A more realistic scenario, where conventional set-top boxes are retained for live premium events, could justify a share price of 200p+.

TAKE OVER TARGET

Pace is positioned in an industry that is long overdue a sector consolidation to improve economies of scale and improve bargaining power with the cable companies looking to fend off the threat of internet TV. With Pace's disappointing results due to profit warnings it is a vulnerable target from a take-over predator. Pace is a commercially viable take-over target from: an industry giant, i.e. Korean giant: Samsung, or a private equity firm.

It is worth noting that Pace's foothold in the US Market could be an attractive proposition for a Korean player for an otherwise hard to enter lucrative market.

Private equity could also be interested at these levels but probably would need…

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Mark Carter

3rd Jul '11

PE could realise and unlock value by selling Pace's 2Wire operation

Pace sees the acquisition as strategically important ("2Wire’s software and gateway expertise will further drive development of our home entertainment convergence strategy" Link), which it bought less than a year ago, accumulating a fair amount of debt in the process. Wouldn't its disposal further reduce Pace's credibility in the eyes of investors?

sudarvesh

Pace is a high risk strategy

AJ Sangha

I agree that Pace can be considered a "High Risk strategy" relative to other stocks but assessed as an independant proposition has limited downside and good upside potential with a significant "market expectation shortfall" discount already priced into the stock.

There are 3 fundamental rationale points which supports my view:

1) Pace is currently trading within 15% of its historical trough P/E (excluding 2009 trough levels in the financial crisis) and also 35% below historical average multiples.

Therefore the following absolute multiples are attractive trading at:
- 0.35x 2012E EV/sales
- 3.1x EV/EBITDA
- 6x P/E on the expectation of achieving 6% EBIT margins.

2) Pace looks attractive from an acquisition/LBO point of view mainly due to its valuation.
Pace has low double digit cash returns and despite low margins, generates steady cash flows that I believe could be attractive to a potential private equity or corporate acquirer. From a corporate acquirer’s perspective, Pace would allow entry into the pay-TV market at a price that is small in comparison to the size of large consumer electronics companies.

Based on my analysis work I calculate an M&A value of 200p/share which equates to 10x P/E or 0.5x sales on estimates (IRR in the range of 20%-25%). However, assuming the company meets its targets, we could see IRR potential of 35%-40%.

3) At current levels, Pace’s market capitalisation of £325m is just slightly above the £300m paid for the acquisition of 2Wire, which could suggest that the market has ascribed relatively little value to Pace’s residual earnings streams.

Thank you for raising this point- I was referring to a situation should a private equity player get involved then at their strategic decision node the private equity player will have to identify all potential opportunities and to realise the greatest shareholder value possible from their point-of-view.

26th Jul '11

Pace has jumped 10%+ today to circa 116p on the back of H1 financials:

Financial Highlights
· On track to meet revised May 2011 guidance
· Revenues increased 21% to $1,187.1m (six months ended 30 June 2010: $978.2m)
· Gross margin 19.0% (six months ended 30 June 2010: 18.6%)
· Profit before interest, tax, and amortisation (EBITA) $68.4m, giving return on sales of 5.8% (six months ended 30 June 2010: $73.3m, return on sales 7.5%)
· Basic EPS of 7.1c (six months ended 30 June 2010: 16.5c), with adjusted basic EPS of 17.1c (six months ended 30 June 2010: 17.9c)
· Interim dividend increased to 1.25c (six months ended 30 June 2010: 1.12c)
· Net debt at $293.2m (at 31 December 2010: $311.1m)

Operating Highlights
Progress made since May 2011 IMS update:
- Inventory management has been normalised, with the majority of the financial impact absorbed in H1
- The Networks business has been re-sized and is no longer loss-making
- Impact of the Japanese Tsunami on potential availability of components has been largely mitigated;
- Initial corrective measures have been implemented to address the profitability levels in Pace Europe
- Acquisition-related synergies were achieved earlier and are greater than anticipated
- Strategic review announced June 2011 underway; aiming to conclude around the time of the Group's Q3 IMS

Outlook
- Given the Group's first half performance, including corrective actions identified and implemented, the Board reaffirms its May profit guidance of $150-170m for Full Year 2011.
- Pace has reported a first-half pre-tax profit due to one-off higher admin costs.
- However, revenues increased 21% to $1.19 billion from last year's $978.2 millio.
- Further, the company's Board declared an interim dividend of 1.25 cents per share, higher than last year's 1.12 cents. The dividend will be payable on December 9 to shareholders on the register on November 11.
- Pace has reaffirmed its profit guidance of $150 million - $170 million for the full year 2011.

Conclusion

- Pace is in a good position for operational turn-around/ recovery with added benefit of the speculative takeover angle.

- The long term story for Pace remains intact and the PE forward rating of 5.8 times 2012 earnings appears too low for a business with a strong position in what is actually a growth industry globally.

- The first half results put Pace on track to meet its revised May 2011 profit guidance.

Pace: The Potential Upside Story?

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AJ Sangha

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