Stock to Watch: Pace

Shares in FTSE 250-listed Pace, a global leader in set-top box equipment for the pay TV industry, are currently interesting; hit by adverse sentiment over a hiccup in the company's order book.

Such delays are inherent to any fast-moving technology industry, but Pace has made matters worse by not mentioning this in its 8 March prelims; instead briefing analysts and press about the matter. Understandably, anyone who bought Pace shares that morning on the basis of a published statement intoning "strong growth", only to see the price plunge from about 220p to 150p, is fuming.

It's not the first time Pace has disregarded proper disclosure: in 2002 it was fined by the Financial Services Authority (FSA) for breaching listing rules. It remains to be seen whether regulators may do anything this time around. Shrewd investors may reckon that if it happens a third time then they quite have themselves to blame for being involved; however this is not really the main issue for perception here; the fall probably relates more to questions about Pace's growth trend.

Customers' equipment renewal and its timing is just one of the reasons why a manufacturer like this can fall short of expectations.

The US customer, understood to be a satellite broadcaster, is moving to next-generation technology in 2012 hence not upgrading this year as previously expected. Pace contends this actually enhances value because the next generation product is likely to be more profitable. Some analysts agreed and only downgraded 2011 profit forecasts by about 6%, however the market is clearly taking revenge, as if this might not be the entire issue.

Indeed, the firm featured as one of Edmond'sfive special situations for 2011, while John Mulligan alsoflagged up Pace on his STAR screening system.

From the 2010 prelims, the sense of "growth" does rather depend on your perspective and you are left relying on management's claim that another year of revenue growth in the order of 17.4% (to £1.3 billion achieved in 2010) is likely. Last year was bolstered by acquisitions with organic revenue growth of 9.7% and management does not clarify exactly how it expects to match 2010.

Operating profit was hit by exceptional items (mainly adding/shedding businesses) and it is debatable what extent of this is needed anyway to sustain such a firm's competitive position. The headline 31.9% rise in operating profit to £91.9 million became £71.1 million at the pre-tax level, a 1.7% annual rise not matching inflation. Segmental information in the accounts shows the existing business grew profit by 7.5% to £101.8 million on revenue up 8.7% to £1,242 million.

Despite a 45% increase in the dividend, you can turn the approach of looking at "adjusted" figures on its head to see that a total 2010 payout of 2.175p per share is covered a fat 11 times by adjusted earnings per share of 23.9p - so the dividend hike does not necessarily underline revenue prospects.

You are mainly judging wider demand for pay and subscription TV services, as well as Pace's competitive position versus the like of Motorola.

Both counts bode well and rapid uptake of high definition services is of particular benefit: for example Pace has recently done very well in the Americas, with 26% growth in US revenues to £541 million equivalent and nearly 100% growth in Latin America to £242 million. The convergence of TV and broadband media and equipment should continue to offer plenty of opportunities. Just be aware, you are still taking quite a speculative view; you can't predict where there might next be a twist. Rapid growth is also likely to increase competition.

Recent acquisitions look strategically intelligent, not just a means to bolster financial results: 2Wire, a US provider of advanced residential gateways for the broadband market; Bewan, a similar business; and Latens, a pay TV software specialist. Net debt has consequently increased to £200.7 million from a net cash position of £73.5 million, so the interest charge will rise.

The balance sheet is also weighted with goodwill and intangibles: rather to be expected when acquiring technology firms, but which may contribute to unease when sentiment is against Pace's shares.

Of £242.6 million net assets, there is £218.3 million goodwill, £176.6 million other intangibles and £28.8 million capitalised development expenditure. Current liabilities also slightly outweigh current assets, with a 33% rise in trade payables to £349.4 million; this could have resulted from the acquisitions, but begs the question whether profit is being enhanced.

The directors appear to believe in value after the share price fall if "trying to catch a falling knife" just recently.

On 9 March, straight after prelims, five directors bought a total 45,344 shares near 185p and as the price dropped to 180p the chief strategy officer bought 20,000 shares (his first purchase although he also has 1.15 million under option). These look reasonable enough purchases although top management has substantially more equity exposure via risk-free options, which do not involve genuine downside.

For more on directors' dealings and their value in your investment decision-making, read:Are directors' moves a signal to success?

In conclusion, you face a technology share that is investment grade in terms of Pace's impressive turnaround that has seen its pre-tax profit grow from about £5 million in 2007; which offers international exposure from the mired UK economy; and to a market leader in a definite growth industry.

Be aware that it is also fast-moving and able to upset forecasts, hence an aspect of speculation.

Yet the share price has moved into a more interesting range, with arguably a large chunk of this uncertainty factored in. Company REFS shows a generally supportive consensus among brokers, looking for about £115 million pre-tax profit this year and £125 million in 2012, for EPS of about 27p rising near 30p. Exane BNP Paribas brings the average down, however, advising "sell" on 9 March (after prelims) targeting about £65 million profit in each of the next two years, for EPS of about 24p.

Risk-conscious investors may want to consider averaging any buying over time and evaluating future updates.

For more information see www.pace.com.