The predictable derivations from unpredictability — Unitek Global Services seesawing

As it is the case for all postings in this blog, my standard disclaimers apply for this posting.  However, since this posting discusses investments, I urge you to review the disclaimers laid out in the About section with extra diligence. Moreover, even if you have already reviewed these disclaimers in the past, you need to review them again, as they are subject to change without notice.  Do it now, and remember that whatever I say in this blog posting is simply my opinion — it is not science, it is not advice, and it is not an attempt to make you act in any way whatsoever.

Background — stepping into a twofer

On June 6th, 2013, I wrote a posting (here) discussing Unitek Global Services, detailing why I have taken a sizable position in the company in spite of its considerable debt — normally an anathema to me and my investment thesis.

As I explained, my investment in the company, which on April 12th, 2013, announced that it had uncovered fraud in one of its division, was based on a possible over-reaction by the market, giving bottom-feeders like myself an opportunity to realize a quick double or two:

Although the direct impact of the fraud is relatively limited and apparently well understood, the market’s reaction was adverse and immediate — dropping the per share price of UNTK to $1, or so, giving the company a market capitalization of less than $20 million for a company with close to $500 million in revenues — a large part of it anchored with DirectTV.

This drop and the resulting market capitalization fundamentally changed the prospects for investors in UNTK. …

As I saw it, while the company’s objective remains the same (with, of course, the added complication that the company needs to manage the risk that has emerged from the covenants, the customer fallout, and the usual predatory law-firm stimulated securities fraud law suits,) a clear short term opportunity had presented itself in the form of an asymmetric risk/reward proposition, with the per share price falling to $1, or so, completely out of proportion to the fundamentals and with limited risk that the per share price would fall further.

Moreover, my expectation was that, once the fall is arrested, then, absent fraud being detected in other divisions, a complete failure in renegotiating the covenants, or the locking down of the customer base, the share price could only go up — and it would do so very quickly. In fact, I was expecting at least two doubles… first a double from $1 to $2, quite rapidly, and then a second, slower, double from $2 to $4.

I was right… somewhat…

Unitek doubleI got my first double when the company struggled through the management of the covenants, successfully renegotiating the covenants without incurring too severe penalties, and fending off three law suits purporting to be class action law suits, with the per share price growing from a low of $0.95 on April 15th, 2013, to a high of $2.17 on May 28th — an easy and very quick double, allowing for substantial gain.

What I did not anticipate was that, subsequent to the double, as the company worked through the next steps, the market would over-react to every single piece of adverse — but, significantly!, expected — news.

The silly market

As Unitek Global Services muddles through the recovery, there is, of course, going to be bad news or something akin to bad news on a pretty regular basis. While the process for recovery from the fraud and its fallout is pretty simple, each step is fraught with complications — particularly around the timing of events — and associated news that can be read by the market as being bad.

For instance, the fraud (which appears to be revenue specific and limited to a small percentage of one division’s results) and the associated announcement that there would need to be a restatement of some of the company’s revenues and earnings caused a technical default on the covenants for the company’s debt, which was seen as bad news and caused the first slide in the per share price of UNTK to $1, or so, in spite of the fact that it was a technicality and was appropriately handled by the lenders and the company through the establishment of forbearance agreements.

Naturally, once the forbearance agreement kicked in, the per share price climbed again.

UNTK - June 28 2013Most recently, Moody announced a severe downgrade of the debt — again, a technicality, originating with the technical default on the covenants and the fact that the restatement has not yet been completed — and the per share price dropped precariously to $1.25, or so, only to resume its growth after a little while, when it became clear to the market that the world was not coming to an end (the per share price is now $1.40.)

Smelling more twofers

So, originally, I had thought that the fraud issue could yield the opportunity for two, consecutive doubles of the per share price for UNTK, first from $1 to $2, and, subsequently, from $2 to $4.

(c) Chicago Daily News.  Published under fair use clause of the 1976 Copyright Act.  DN-0000074, Chicago Daily News negatives collection, Chicago History Museum.

(c) Chicago Daily News. Published under fair use clause of the 1976 Copyright Act. DN-0000074, Chicago Daily News negatives collection, Chicago History Museum.

Clearly, because of the market’s idiocy, this is not the case, and, rather, the fraud issue uncovered by the company and pounced on by for-hire lawyers and the market yields almost any number of opportunities for doubles, including some in the range from $1 to $2.

This, of course, does not mean that the the per share price could not, reasonably, be expected to over some time period return to the $4 level — or above. Instead, it means that for the intrepid investor with nerves of steel and a good eye for timing there are additional opportunities to reap gains throughout the process.

Capitalizing on these opportunities would require two things: (1) an understanding of what will probably happen with Unitek Global Service throughout the process of recovery, and (2) an — at least partial — abandonment of the wait-and-hold approach to UNTK.

Enjoying the seesawing

From a 70,000 feet perspective this is a simple chronology of what I expect is going to happen with Unitek Global Services: (1) the company will refinance its debt as per the requirements raised by DirecTV, (2) DirecTV will confirm its support of the company, (3) the company will announce its earnings and revenues for fiscal year 2012 and for first quarter of 2013, restating earnings and revenues for 2012 with resulting significant earnings loss, (4) the company will focus on operating its business and bringing down its debt, (5) the purported lawsuits against the company will be settled or otherwise disposed of, and (6) the debt will be paid off, possibly through a secondary offering once the per share price has normalized.

Point 1 refers to the Termination Notice Withdrawal Agreement between Unitek Global Services and DirecTV, an ominous sounding contract name, which actually covers something very pleasant: An agreement whereby, given certain terms, DirecTV will commit large amount of business to Unitek Global Services.

With respect to the per share price, these are my prognostications:

  • Until something happens, then, ceteris paribus, the per share price should appreciate at a fair clip, reflecting the value opportunity
  • If either of points 1 through 3, in the above, does not happen before the results for the second quarter are due, before the next interest payment is due, or before an expiry of a deadline imposed by DirecTV,the company’s largest customer, then it is likely that there will be a significant drop in the per share price as each point’s deadline is surpassed, with a probable floor of $1.25
  • Achievement of either of points 1 through 3 should cause a significant leap in the per share price
  • Points 1 through 3 should be interconnected and should occur almost simultaneously. If they are disconnected (i.e. if one point happens, but another does not,) or if they do not occur near simultaneously, then the per share price is likely to experience one or more significant drops. Point 3, in particular, will lead to a significant drop in the per share price if it is not offset by good news with respect to refinancing and the DirecTV releationship
  • Point 4 should bring a slow, but steady appreciation to the per share price, assuming that the fraud issue has not substantially undermined the flow of new business
  • Point 5 should cause an immediate jump in the per share price in spite of being a near non-event
  • Point 6 is the Promised Land. Once the debt is paid off, Unitek Global Services’ free cash-flow should explode, and the per share price should grow by a steady clip, provided, of course, that the dilution accompanying the debt pay-off is not totally insane.

Naturally, should the company end up in a situation where it feels compelled to declare some form of bankruptcy or seek bankruptcy protection, the issue of the per share price will be moot, with the common shareholders’ equity position most probably being wiped out.

And, so, the issue is that given the complexity of getting all the pieces right and doing so with the right timing and given the fickle nature of the market there will probably be seesawing in the per share price of UNTK even if Unitek Global Services is able to do all the right things and even if it is clear that the per share price of UNTK will ultimately revert to a meaningful level (assuming, of course, that there is no catastrophic failure, causing the common shareholders to be wiped out.)

So an investment in Unitek Global Services by way of UNTK can be viewed in three ways:

  • One can choose to believe that buying shares in Unitek Global Services is a bad investment because the per share price may seesaw, causing temporary, non-realized gains to be wiped out
  • One can choose to believe that buying shares in Unitek Global Services is a good short- and medium-term investment because the per share price may seesaw, yielding multiple opportunities to, as the traders put it, get one or more twofers
  • One can choose to believe that buying shares in Unitek Global Services is a good long-term investment because the per share price is depressed, providing for an excellent buying opportunity now, and because the seesawing will provide for additional buying opportunities over time

Sometimes there is comfort in not being the only shark in the water

Recent SEC filings seem to confirm that there are institutional investors that agree with the two more optimistic viewpoints I laid out in the above. On May 16th, 2013, Red Oak Partners filed an SC13 filing disclosing that it had accumulated a position of 945 thousand shares, equal to approximately five percent of the outstanding shares, and on June 26th, 2013, John Randall Waterfield filed an SC13 filing disclosing that he had accumulated a position of 1.2 million shares, equal to approximately six percent of the outstanding shares.

Now, I don’t know which of the two optimistic viewpoints and associated investment strategies Red Oak Partners and John Randall Waterfield subscribe to, but, clearly, they do not agree with the sentiment underlying the depressed share-price, that the company is about to go into the crapper. And clearly, like me, they are more amused than scared by the panicked reaction by the market to every single piece of the stream of predictable news released by the company as it navigate the waters that the unfortunate — but ultimately immaterial — fraud-announcement has thrown it into.

So, in spite of the market idiocy — and, of course, in spite of the element of risk inherent in the current situation — I will keep on betting on the company. At least I know that I am not alone.

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