Sold UTSI at $5.50

Last Thursday brought a big disappointment from UTStarcom, just two days after we finally picked up shares at our target price of $7.75. The company reported three pieces of bad news Thursday night after market hours:

– One of its clients, Softbank Broadband, will not pay $40 million in time for quarterly reporting

– Its gross margin guidance slipped from a midpoint of 16.5% to a midpoint of 10%

– The SEC launched a formal inquiry into the company’s past financial disclosures

That led to a Friday opening price of $5.75 before we could do anything. No stop-loss order could save us, even if we’d had one on the books. The damage happened after hours. I sent subscribers a note to saying to place a stop-market order at $5.50.

This latest development casts doubt on management. These issues are similar to the ones reported in January and are exactly what management was supposed to have fixed. Excellent value analysts began liking the stock below $8 for precisely the reason that the earlier bad news had dropped it from $20. Now that the same mistake has happened again, it’s hard to have faith in management’s ability to turn things around.

The damage had been done and the smart way to manage the trade was to hope for a recovery with a stop-loss in place. The same catalysts that led me to target UTSI in the first place are still present. The company has a healthy marketshare in China, the late $40 million will be paid because the client also owns 12% of UTStarcom, and current UTStarcom management bought a slew of stock between $13 and $16 per share in September of last year. I imagine nobody is more keenly aware of the company’s shortcomings and depressed stock price than they are.

Not surprisingly, UTStarcom (UTSI) continued falling on Monday and our stop-loss order to sell at $5.50 filled. That’s a loss of 29%. This is extremely disappointing, I know, and particularly hard to take given the tough go we had with PXRE Group last month. For me, too, it was a personal disappointment because it’s the second time I’ve been burned by this stock. I watched it from Feb. 11 after we sold at $15.10 for a 9% loss, looking for reforms to take hold and give us a chance to buy in at a better bargain to ride the recovery. Buying back in again at $7.75 on improved analyst forecasts and positive management guidance seemed prudent. After all, that’s a 49% discount from the earlier sale price. However, it turns out that management was not accurate in its guidance, warned last Thursday night, and is now the subject of an SEC probe.

Prior to the PXRE Group disappointment and the UTstarcom letdown, The Kelly Letter had suffered just two losses in the previous three years.

In one month, we’ve added two more. This does not sit well with me. I’m eager to get my clean record back. To that end, I’m pleased with the rest of our portfolio as we’ve built it for the winter recovery, and I’m still eyeing potential additions.

As the winter rally commences at the end of this month or beginning of next, we’ll enjoy watching all of the slightly negative positions turn positive.

We’ll come out ahead. We always do.

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