Edmond Jackson's Stockwatch: Pace

Last July I drew attention to TV set-top box technology provider Pace in a 130p range after its interim results showed quite an impressive turnaround by a new chairman and chief executive, the then FTSE SmallCap shares trading on a single-figure price/earnings (P/E) multiple following historical mishaps.

The story shows how new management and a turnaround plan, coinciding with cautious sentiment, can achieve a useful re-rating: Pace has since re-rated to test 250p and re-entered the FTSE 250 index as the turnaround gained traction.

Based on current forecasts for a big advance in profits and earnings this year, with moderating but still double-digit growth anticipated for 2014, the forward P/E multiple remains in single figures - so Pace's risk/reward profile looks favourable if speculative. Most likely the market seeks more evidence of solid trading without nasty surprises.

Valuation does rather rest on the earnings trend since the prospective yield is only just over 1.5% and there are $560.5 million (£362.9 million) intangible assets versus $460.1 million net assets, hence negative net tangible assets. However cash flow is improving and management expects a positive cash position by end-2013 which should help limit downside risk. In recent years the main risk factor has been operational - the group's supply chain - however management says its transformation continues well.

The company's latest interim management statement cites "an encouraging start to the new financial year with strong revenue growth... we expect revenue for the first half of 2013 will be ahead of the first half of 2012, driven largely by continuing demand for media server products in North America and the comparative half being impacted by hard disk drive supply disruption."

While the bottom line is "profitability in line with our expectations" this update affirms consistent progress, which helps build a foundation for another re-rating. On an historic earnings basis the P/E multiple has improved over 17 times, but assuming a near doubling in earnings per share this year to about 26p, then 29p in 2014, the P/E is eight to nine times. These are converted figures - Pace reports in US dollars with 71% of revenue derived from the Americas (55% Latin America).

Another likely reason for the modest forward P/E is the longer-term need for revenue growth. The turnaround is expanding margins - the operating margin has improved from 3.2% in 2011 to 3.9% in 2012 and is projected at 7.5% for 2013 - but 2013 revenues are expected to be broadly in line with 2012. Pace will need to show it can invigorate sales for when margin improvements peter out.

Projecting fast-moving technology is a proverbial headache, but Pace is reconfirmed as market leader in pay TV hardware and the global number one in set-top boxes and residential gateways - a commanding position to furnish inevitable changes in home media delivery.

Pace is also diversifying into software/services/solutions, gaining customers such as British Sky Broadcasting, Foxtel and Telstra (in Australia). Pace's ECO service management software suite supports some 25 million devices globally. Bear in mind, the story can sound great but it all boils down to revenues/margins.

The early March preliminary statement cited encouraging demand in a resilient pay TV market and it will be interesting to see this year if Pace does better in the fast-growing Latin American market, where it is well positioned. While profits there rose by double digits, revenues dropped over 20% as low-end set-top boxes were reduced; however Pace has diversified its technology offerings now to supply eight of the 10 largest pay TV providers.

The North American market is the largest for digital pay TV and broadband, but is only expected to see low single-digit annual growth in subscribers for the foreseeable future; yet Pace's revenues there rose by 23.7% last year due to success with its media server products in the second half; also gateway revenues grew by 14.5%; and management is confident about its products' offering for this market.

Revenues fell over 12% in Europe however, following a reduced win rate for new products. Sales performance is said to be improving in a single-digit growth environment; likewise demand from operators for integrated solutions. "Rest of world" markets have been mixed amid hard disc drive supply disruptions, although progress looks good in Australia and New Zealand, also India which is a key growth market.

So Pace looks to have positioned itself as well as practically possible for global reach, but investors need to appreciate there are going to be occasional jolts with technology adaption and acceptance. Mixed performances make it tricky to project group revenues. But overall the Pace story is one of turnaround and lead positioning in a global growth market, with good progress improving the group's financial profile. Net debt fell by nearly half last year to $163.3 million, meaning a $13.7 million net interest charge took 14.6% of operating profit relative to 26.1% in 2011, and this cost should reduce further.

Moderate risk-tolerant investors should therefore continue to follow Pace as it offers another buying opportunity if revenue growth can evolve.

For more information see pace.com.