Edmond Jackson's Stockwatch: Try and keep up with this media mid-cap

Is Pace sound? Shares in mid-250 company Pace, the home media technology group best-known for its set-top boxes, dropped from 360p to about 300p, ironically since its 28 July interim results raised expectations for 2014 profits and cash flow; the problem being that the finance director - approaching two-and-a-half years in the role - has suddenly departed.

With no reason given in the announcement and the anecdotal apology of "personal reasons that remain confidential" enough traders have sold in a thin summertime market, to cause a drop. There is also a wider downturn in enterprising shares as international political worries conspire for a sentiment change to "risk-off". But while Pace has a volatile history, its leading position in pay TV and broadband technology make it worthy of attention in a jittery stockmarket. Despite some bumps with technology adoption, rapidly advancing broadband should sustain demand; also the benefits of a strategic review initiated in 2011 continue to flow and should be stronger than any individual director.

In a chart context the drop effectively takes Pace back to a circa three-year upward trendline after a plunge from above 200p as low as 44p in late 2011 - amid the wider bear market and supply chain issues following the Japanese earthquake and flooding in Thailand. Then, a change in chief executive, and also the chairman - Pace appointed serial "strategic reviewer" Allan Leighton - led to a progression of strong results as shown by the table.

Cash generation

In a five-year context, the stock's rise to 484p last springtime was a spike - possibly a blow-off of exuberance in a liquidity-fuelled stockmarket, shown similarly in the charts of other enterprising shares. However, Pace should be distinguished for its strength of cash generation - in contrast with other popular technology-related stocks such as Quindell and Globo - trading on about five times cash flow per share, which ought to lend support even though the dividend is barely over 1%.

Note the company reports in US dollars even though databases (such as the table) may quote in sterling. Management has guided the market towards a revenue expectation of about $2.7 billion (£1.6 billion) for 2014 as a whole despite first-half revenue down 13.6% to $1.14 billion (£677 million), with new product launches being made in the second half "regaining leadership with several key customers plus increased demand for network products".

A 16.7% revenue fall in the key US market, to £699 million, is an obvious concern and with low single digit annual growth for subscribers anticipated for the foreseeable future. A carrot is extended: "high levels of competition between service providers will drive accelerated technology refresh cycles" although investors have taken the cautious view in waiting for proof how this evolves. e.g. with rivals' shares such as Arris Group also weak. Growth share investors are typically sensitive to a revenue drop.

More positively, the late-2013 acquisition of Aurora Networks, to enhance Pace's broadband technology has reportedly gone well and "the underlying demand for Aurora products is well ahead of our expectations with record levels of orders." Further acquisitions should be facilitated by strong group cash flow: after generating $209 million in 2013, this year is expected to see in excess of $200 million similarly, with $122.4 million cash on the end-June balance sheet.

Special dividend

A special dividend is another possibility, although if the board is genuinely confident that this scale of cash flow can be sustained then it ought to re-rate the regular dividend more than a 23% hike in the interim payout. While there is scope to continue reducing net debt of $167.6 million at end-June, earnings cover for the dividend is projected to grow over seven times - somewhat excessive unless the board remains wary this might get compromised. For example "technology refresh" in a competitive market implies ongoing investment; an aspect of running to stand still.

The price/earnings (P/E) multiple is now modest. At about 310p currently, off a 295p low post-interims, Pace trades on 10 times the consensus 30.6p normalised earnings per share estimate for 2014 - representing over 50% annual growth. While this apparently moderates to 9% with the consensus projecting 33.4p for 2015, Exane BNP Paribas published a 41.2p estimate on 29 July when advising 'buy'. With fast-moving technology it is hard to forecast reliably beyond six months although this specialist area should remain buoyant as bandwidth increases and "media everywhere in the home" takes hold. Capitalised around £1 billion Pace has breadth of resources to exploit this while being of a size that can still achieve attractive growth. If financial statements pan out broadly well then the P/E can improve besides earnings.

Some investors have clearly taken a cautious line after the finance director's stepping down, mindful how departures "with immediate effect" can imply disagreements at best and even trouble ahead. Directors' contracts are meant to offer a company and its shareholders protection from a director waltzing off, unless there is wrong-doing. In reality they do as they wish and investors are left guessing - so until Pace affirms trading with a mid-November Interim Management Statement, some uncertainty will linger.

My observations on Pace bear parallels to when I drew attention two years ago at 130p: a modest P/E, a 15% rise in the interim dividend massively covered by earnings, albeit some challenge as to longer-term visibility. The share price rise implies a winning strategy in a vigorous technology market; perhaps the essential reasons to consider this stock.

For more information see www.pace.com

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.