Sunday, July 24, 2011

PIC.L - Pace - an event-driven situation

Bottom Line Up Front

Pace's share price has been hit hard by two mis-steps during the year. Concerns have also been expressed for the need for additional equity finance, the outcome of a forthcoming strategic review, and doubts about the future operational performance of Pace Europe. At a share price of 107.7p, it has an unleveraged earnings yield of 14.8%, and a return on tangible capital of 140%. It appears that the market has over-reacted to recent temporary setbacks, creating a buying opportunity.

Brief Description of Trading Activities

Pace makes satellite, cable and IPTV devices for PayTV operators. IPTV (Internet protocol Television) refers to TV content delivered over the internet instead of traditional methods like radio frequencies, satellite or cable [1]. PayTV refers to subscription-based television services, like BSkyB.

Pace manufactures STB's (set-top boxes). These are electrical boxes that receive incoming signals (from satellite, cable, etc.) and decode them to produce output that televisions can use. A PVR (Personal Video Recorder), which records programs on a hard drive instead of video tape, is one example of an STB. There are many models of STBs, depending what they do: whether they receive signals from satellite or cable or internet, whether they can record programs for playback or not, and introduce new features like high definition improved compression technology, and ease-of-use.

Year to date

PIC's share price was around 183p at the start of the year, rising to 229p at around mid-February. On 08-Mar-2011, PIC announced its results for y/e Dec 2010, noting strong revenue growth, strong earnings growth, increased returns on sales, and three acquisitions [2]. However, the share price plunged from 220p to 165p (25% down) over the course of a few days. This was due to an exceptional charge of £19m for acquisition costs and a delay in customer upgrade plans, both of which were unexpected by investors.

The share price then drifted downwards to 153p by 09-May-2011. On 10-May-2011, PIC issued an IMS (Interim Management Statement) [3], stating that the Japanese Tsunami had created supply chain problems, that the profitability in Pace Europe had been below expectations, and that Pace Networks has been closed as a standalone business unit due to insufficient demand. Consequently, the share price plummeted to about 93p on heavy volume. Since then, the share price has recovered to about 107p (51% down on its earlier peak).

I had elaborated on these issues in a blog post [4], noting that the increased debt of the company made it more risky than formerly, and that Altrium Securities challenged the credibility of the reasons contributing to the lowered margin expansion cited in the IMS.

On 31-May-2011, PIC announced that Mike McTighe retired as a director of the company, and proposed Allan Leighton as its new non-executive chairman [5]. Mr. Leighton is a former CEO of Asda and non-executive director of the Royal Mail. He took up the PIC role on 21-Jun-2011. He will perform a strategic review of the business, and should improve the communication flow with the City.

On 21-Jul-2011, Numis downgrades PIC from hold to reduce. They are concerned with a possible painful transition following Mr. Leighton's business review, the possibility of needing to issue equity to refinance their debt, and uncertainties over the future performance of Pace Europe.

On 26-Jul-2011, PIC will announce its Interim 2011 Earnings Release.

Quantitatve/Technical reasons for purchase

PIC has suffered two significant gap downs on heavy volume during the year, dropping its share price to levels not seen since April 2009. Analyst forecasts expect an 11% decline of EPS for y/e Dec 2011. Clearly, there is a lot of negative sentiment and uncertainty surrounding the company.

Using a quantitative approach suggested by Joel Greenblatt [6], PIC has a high ROC (Return on Capital) and UEY (Unleveraged Earnings Yield). Greenblatt's formulation of ROC is based on EBIT (Earnings Before Interest and Taxes) over Tangible Capital Employed. UEY is based on EBIT over EV (Enterprise Value).  Sharelock Holmes reports figures of ROC as 118% and UEY as 13.8%. According to my calculations, ROC is 140%, and UEY is 14.8% [7].

The FTSEALLSHARE stands at 3088.36. PIC is on an ask price of 107.70p


Long position, no intention of changing in next 72 hours.


[1] IPTV Wikipedia -
[2] Prelim results for y/e Dec 2010
[3] Intermin Management Statement issued 10-May-2011
[4] Pace - I got it wrong
[5] Allan Leighton To Become New Chairman Of Pace plc
[6] The Little Book That Beats The Market
[7] Spreadsheet calculations of ROC and UEY


Lewis said...

Good stuff Mark.

I like PIC, I'm just so uncertain on this and next year's prospects that I'd rather wait for the next release and see where we stand. Perhaps I'll miss the boat, but I don't have any conviction on it.

The earnings yield and ROC numbers are definitely attractive, and the 'painful transition' reason just screams poor logic to me. Painful transition or otherwise, in fact it only presents upside if Leighton can make further improvements to what's already a very profitable business.

Mark Carter said...

I'm pleased to report that I didn't make a complete fool of myself with my article. Pace did a webcast where they went through their IMS. In the unlikely event that Pace head honchos are reading this: many thanks, it was a good idea.

The acquisitions seem to be going well, contributing to higher margins. Europe is problematical, and the board mentioned Italy particularly. The board seem inclined to exit markets where they feel that margins are inadequate; which seems like a sensible enough strategy.

Numis downgrading PIC from hold to reduce was a godsend. I was writing to an investor who said that some of his best picks were where analysts put a share on Hold, and subsequently put them on Buy. So the moral is: don't get too twitchy at analyst rating, they could well be a useful contrarian indicator.