China's economy is expanding rapidly, and its telecommunications infrastructure has trouble keeping up with demand. The problem is exacerbated by the significant numbers of rural villagers moving to the cities in search of a better life. According to some recent economic studies, urbanization in China is expected to increase from 35% in 2000 to 55% in 2020, a migration of 260 million people--about the population of the United States.
Telecommunications infrastructure must be built to support this potential growth, but wireline is inefficient and expensive, and the average Chinese citizen can't afford wireless technology. UTStarcom, based in the United States but with most of its operations in China, has a 60% share of the Chinese market in wireless technology called Personal Access Services. It works much like a cordless phone system, but it allows for greater range throughout town. It's also half the cost to the consumer of second-generation wireless service. Personal Access Services helped UTStarcom double sales last year, and the company is projecting a more modest 20% to 25% growth in revenue this year.
UTStarcom isn't content with growing in China alone. It's expanding into other emerging nations, including Honduras, Mexico, and Vietnam, all of which have nicely growing economies and an inexpensive telecommunications network. China represents 83% of revenue, but the company projects growth in Vietnam, Latin America, and other developing countries will reduce this amount to 50% in five years.
Doing business in emerging markets is fraught with political and economic risk. Though the growth prospects of China are clear, it's still a developing country. This raises the level of financial risk for investors because of the higher level of political risk consistent with developing countries versus developed ones. In addition, competition from emerging technologies will make some inroads over time.
UTStarcom's stock price seems relatively cheap to me, reflecting investors' unease with emerging markets and the future of Personal Access Services technology. With sizable growth in wireless handset and telecom infrastructure, I project that revenue should grow at least 25% this year and at least 15% annually over the next few years. Operating margins are likely to settle in the 13% to 14% range, and the company should generate $200 million in free cash flow this year by my estimate. A company with a potential future like this in developed markets would likely trade at a much higher price/earnings multiple than the S&P 500. However, UTStarcom's 2004 price/earnings multiple, based on Wall Street consensus earnings, is 17. Given its growth prospects, this multiple seems eminently reasonable to me. I haven't been able to say that about too many companies lately.
William Schaff is chief investment officer at Bay Isle Financial LLC, which manages the InformationWeek 100 Stock Index. Reach him at [email protected]. This article is provided for information purposes only and should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any security. Bay Isle has no affiliation with, nor does it receive compensation from, any of the companies mentioned above. Bay Isle's current client portfolios may own publicly traded securities in one or more of these companies at any given time.