PIC.L - Pace - I got it wrong

Having been so bullish on PIC.L (Pace), I have now reversed my opinion. I originally bought on growth expectations at reasonable price. Although revenues look set to continue expansion, there appears to be problems on the cost side. Pace has hit a number of speed bumps this year, and it is clear that the rosy picture I had envisaged originally is fading fast. Pace is infamous for being a "serial disappointer", and this year it has seen it perform a veritable tour de force on that score.

Even as recently as 18 April, a time when PIC was at 153p (now at 97p) I commented that on a PER of 6 and double-digit growth expected, it was clearly undervalued. I did note some risks. I seems tht those risks are now increasing. Let's recap the position as I understood it at the time. The good:

• y/e Dec 2010 reported revenues up 17%, EPS up 24%
• Similar levels of revenue growth expected in 2011, and improved return on sales on top of that
• "Overall, the Board is confident that Pace has created an excellent platform for growth as its customers continue to lead the global evolution of managed digital services into and around the home."

The bad, which caused the share price drop in March:

• exceptional charge of £19m for acquisition integration costs
• delay in a customer upgrade plans to 2012

 In a trading update yesterday, Pace reported the following:

• increased costs due to inventory building
• Japanese Tsunami exacerbating supply chain issues
• Pace Europe profitability below expectations
• closure of Pace Networks as a standalone business unit due to insufficient demand
• Operating profit expectations for 2011 reduced to £97m-£110m
• Pace Americas performing ahead of plans. Well, at least that's some good news.
• Pace Europe has continued to win business, for example with Tata Sky in India and Net Servicos in Brazil
• the first half underperformance will not be made up in the second half

Some views on the boards, including FT Alphaville:

• consensus downgrades to 2011E forecast of c. 25% in EPS expected
• switching KPI (Key Performance Indicators) is a worrying sign of moving the goalposts. As Warren Buffet would have it: painting the target around wherever the arrow landed
• the market is complex, and it's difficult to know who the winner will be
• Since the acquisition PIC has lost the cash and lost the positive net tangible assets - leaving it with a nice PER and a small dividend. If the PER is now threatened I'm not seeing much attraction. 
• there is suspicion over the reference to "operating profits" rather than pre-tax profits, suggesting that there could be some nasty exceptionals coming up
•  Massive dent to board confidence today, Mr. Tighe needs to think wisely, lessons not learnt still after all these years.

Perhaps the most damming indictment comes from Altrium Securities, as reported in the Guardian:

The [IMS] statement offers a list of reasons that contributed to the lowered margin expansion, none of which seems to be credible in our view [emphasis added]. This statement also stands in stark contrast to the first quarter performance of its two closest peers – Motorola Mobility and Technicolor. In the first quarter, Motorola's set-top box revenues were up 11% and Technicolor reported flat revenue growth (unit growth of 21% year on year). Both these vendors remained bullish about the prospects of the market and did not highlight any pressure on margins. In addition, the closure of Pace Networks is a surprise particularly as this was a "key area" of opportunity in 2009.

The numbers: PIC has rebounded 5.3% this morning, compared to a drop of about 40% the day before. Based on a closing price of 92.9p, I have the following numbers on a rolling basis: PER 3.9, 83% gearing, PBV 1.2, PFCF 63. z score 1.9, EV/EBITDA 3.3, interest cover 51, net debt £201m, negative tangible value £-181m. I will refrain from posting broker estimates, as they seem a gonner now.

My position: I am a disgruntled holder of Pace shares. Now that my view on Pace has significantly deteriorated, my original reason for buying has largely evaporated. That being the case, it is not a "buy" under my original premise.  On a PER of 3.9, and an EV/EBITDA of 3.3, I don't think it's a sell either. With an interest cover of 51, and a net debt of £201m compared with net profits for 2010 of £50m, I am not too concerned with the debt position at this point in time. Risk is building up in this company for sure, and growth is evaporating. Given the low PER and EV/EBITDA rating, I think that a doubling of the share price is possible. Pace is of a much poorer quality than I originally imagined, and I do not now view it as a good growth share. I continue to hold.