Alpha Neuron

Mobile operator messaging revenues are under threat. Operators are rolling out flat rate data packages to encourage mobile Internet usage and uptake, which is in turn enabling the availability of free, ad-funded online messaging on the mobile handset. Mobile application development is by nature technically challenging. However, the carriers have not helped. Mobile technologies are making mission-critical data (voice, data, video, maps) available on-demand and on-site through mobile networks and devices. Many organizations are planning remote access to their production-level enterprise applications.

Existing Internet Protocol (IP) broadband links (such as DSL or cable) are leveraged to back haul the mobile voice, video, SMS, and data traffic from the home and integrate with an existing 3G Wireless Core Network.

Base Stations are the link between wireless devices and the rest of the world. While many people would recognize the large cellular towers on the roadside as base stations, there are also smaller, lower power base stations for indoor wireless applications.

Base station manufacturers also want to evaluate the new standard. TI partnered with system developers MCS and STx to offer ATCA/AMC-based development platforms that can reduce the OEMs’ time to market. Basestations will require flexible, low cost integrated solutions that are capable of supporting several-standards.

For example, let’s analyze Powerwave Technologies:

Powerwave Technologies, Inc., is a global supplier of end-to-end wireless solutions for wireless communications networks. Powerwave designs, manufactures and markets antennas, boosters, combiners, filters, repeaters, multi-carrier RF power amplifiers and tower-mounted amplifiers and advanced coverage solutions, all for use in cellular, PCS, 3G and WiMAX networks throughout the world.

They have 3 product lines: (1) Antenna systems (2) Base station systems (3) Coverage systemsBase station systems contribute about 67% of the revenue, while Antenna systems and Coverage systems share the remaining.

Powerwave is in a challenging position. The industry has long-term strength, but the short-term is not easy.

Powerwave has two types of customers:
(1) OEM Accounts, contributing about 67% sales and
(2) Direct/Operator Accounts, contributing about 33% sales.

Powerwave has done four acquisitions in the last few years, and in their words: “Notwithstanding our acquisitions, our business remains largely dependent upon a limited number of customers within the wireless communications market and we cannot guarantee that we will continue to be successful in attracting new customers or retaining or increasing business with our existing customers.”

The 67% sales from OEM Accounts creates earning risk because of developments in the OEM side, given that 50% of total sales come from just two OEMs: Nokia Siemens and Alcatel-Lucent. They need to do a couple of things successfully if they are to move into profitability.

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Capital structure is part of fundamental business strategy, and top-level driver for Financial Management. And every business owner/board should have a map for how capital will be obtained for various projects.

Capital structure decides what combination of debt and equity will be used to finance the business projects. And it thereby decides the value basic parameters like cost of capital, earnings per share and valuation.

Arriving at the capital structure will depend on multiple factors: owner/shareholder expectations, industry type, tax policy-high corporate rates favor debt, and overall corporate risk.

Assuming there are real projects to deliver real growth (an important assumption), then if company’s equity investors expect the stock to go up 10%+ per year, and if the company can borrow money at 6%, then the company should have some debt as a source of capital.

Now, the point to note here is that it will benefit the equity investors and share price to have some debt, but overuse of debt (over-leverage) is not healthy because it increases the risk in the company’s earnings stream, which in turn tends to lower the valuation and hence the share price.

So each business owner/board will have to find their zone of comfort and create a capital structure policy that makes a trade-off between risk and return, which is acceptable to all investors.

Deal Analysis:

Its always advisable to buy a running business than to build one from scratch — where possible. Virgin has done that in this case.

It would have cost Virgin about $25 million to build/replicate this platform from scratch. Helios has it up and running. $39 is like a 50% premium, and if you consider time and execution risk, that’s a good deal.

Given that this is electronics and mobile business where costs keep falling and trends keep changing, one of the things that Virgin Mobile has to rapidly do is to reduce the handset inventory of 85,000 devices valued at $17 million. If they are not sold off soon, they will probably be worth $7 million a year from now.

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Deal Details:

The rumored VirginMobile/Helio deal is now a reality. Virgin Mobile USA will acquire Helio from SK Telecom and Earthlink for an equivalent of 13 million shares of Virgin Mobile stock with a value of $39 million. Virgin Group and SK Telecom each will invest $25 million in equity capital in the company. SK will have a 17 percent investment in Virgin Mobile and two seats on the Virgin Mobile board of directors. The deal is supposed to close in the third quarter.

Virgin says that the Helio deal will be good for the MVNO because it will allow the company to offer differentiated data applications and enter the postpaid market. Helio has approximately 170,000 subscribers with an ARPU of about $80 and a handset inventory of 85,000 devices valued at $17 million. By acquiring Helio, Virgin expects to increase its volume of minutes and therefore drive down the company’s cost per minute network usage deal that it has with Sprint. On a conference call this morning with investors, Dan Schulman, CEO of Virgin Mobile USA, said that Virgin’s agreement with Sprint is no longer tied to Sprint’s costs but instead is based on total revenues that Virgin delivers via airtime minutes and megabytes of data. Schulman says he expects a minimum 8 percent discount on network costs in 2009 with further reductions in subsequent years. “This reduces our third-party risks…and allows us more margin,” Schulman said.

Virgin also will acquire Helio’s postpaid platform, which Schulman estimated would cost the firm between $20 million and $25 million to build if Virgin wanted to try to replicate it from scratch. Schulman says that this platform is strategically beneficial to the firm because 20 percent of the firm’s disconnects come from customers going to postpaid products so he believes that offering postpaid service will be a retention tool for Virgin.

Nevertheless, Schulman asserts that Virgin doesn’t want to attack postpaid incumbents with a postpaid offering. Instead he believes that the integration with Helio will allow Virgin to reduce its churn and appeal to higher spending customers “We will focus on the quality of our base, rather than growing aggressively,” he said. “We have modest postpaid expectations.”

Schulman added that Helio will cut its sales and distribution costs before the acquisition closes. That means the company will shut down its five retail stores and kiosks. Helio’s store in Denver had closed.

Virgin will use the investments from SK Telecom and Virgin Group to pay down its debt. Both SK and Virgin also will provide an additional $35 million and $25 million respectively to increase Virgin Mobile’s revolving debt facility to support ongoing growth.

For more: See this press release

How many times have you made payments/investments for promised results which never happened?

Well, I have made that mistake a few times over the last 2 decades, and each time, the learning has improved.  And the success rate of deals has also improved.

There are professionals of all types - who will ask for upfront money - and then you are stuck. It happens in every possible industry. It is very common and we see many cases regularly. And hence this post.

Whether it is a simple project, or a real estate, or a business, or anything else - if you are planning to spend money on it - please make sure that there is a payment schedule that is tied to milestones, mutually agreed between you and the other party.

Here’s an example of Milestone Based Payments - it ensures that the other party will continue to work for the results.

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Novartis buys drug firm Protez for $400m 

ZURICH, 5 June 2008: Novartis has bought US-based Protez Pharmaceuticals in a deal worth up to $400 million, giving it rights to an antibiotic which could be used to fight superbugs such as MRSA, the Swiss drugmaker said.

“The acquisition of Protez Pharmaceuticals provides rights to PZ-601 and further strengthens specialty medicines development portfolio in hospital infections,” Novartis said. Z-601 is a novel broad-spectrum antibiotic in Phase II development against potentially deadly drug-resistant infections, including MRSA and ESBL strains, Novartis said.

Novartis will initially pay $100 million for privately held Protez, with a potential for up to $300 million of additional payments depending on the success of PZ-601, the company said. The emergence of hospital superbugs such as MRSA, which are resistant to existing medicines, has increased the need for alternative treatments and re-focused attention on antibiotics.

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A point to note is that milestone based payments will result in a larger number for the total project cost/ business valuation - compared to upfront payment - but in my experience that extra is well worth the reduced risk, especially in transactions with strangers or new business partners.

Despite best effort, there are unknowns in the business environment which will come into play as time progresses - and Milestone Based Payments give you the ability to adapt better.

Best Wishes,
Shankar/ Director, Alpha Neuron

Just take a look at the following section - it’s from BBC website on Jan 20, 2002 - when the global economy was severely down, and almost every tech company was losing revenues and market value on a daily basis.

Profits plunge in 2001

Motorola slashes jobs Infineon chip slump Dell’s price war Ericsson shock Unisys profits halve Sony’s heavy losses Fujitsu slides into red Compaq losses mount Microsoft profits drop Nortel struggles Nokia sales fall IBM rare success Ad slump hits AOL Intel tumbles Bruised Apple Philips’ hefty losses Yahoo suffers Psion’s woe Palm sales halved Baltimore’s cash crunch Marconi battered Alcatel sheds staff Lucent losses widen Cisco slumps

As you will notice, all kinds of problem happened to leading tech companies in 2001-2002 - part of the reason was that they had built structures and teams very recently in 1999-2000 that were preparing for future growth - everyone was preparing - nobody wanted to be left behind - the problem being that the growth projections were just too steep. Some tech companies had planned 500-1000% increase in revenues in 2 years, and those were inflated business plans.

The situation was not very different from non-tech companies.

The question is: How does one prepare for such situations? What are the learnings from last time, which we can put into use the next time business slows down?

If you go through the above links, there are some lessons for every business owner and executive:

1. Consciously increase the Cash and Current Assets on your balance sheet from many months before you actually are in the middle of bad business season.

2. Watch your Debt/Equity, and take any possible steps to reduce the debt component, while the market is liquid.

3. If you have been thinking of selling off a business unit or a brand - because it’s not fitting with your long-term business strategy - decide Yes or No rapidly - and if it’s a Yes - then do it with top priority - otherwise it is very likely that you are losing valuation on it.

4. Outsource as much work as possible - preferably foreign countries - it helps to have business partners/vendors who are located in other markets - because they will have an incentive to help you get new business in case you are facing business slowdown in your home markets.