Blackfriar: Pace could still box clever as technology forever changes

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STILL smarting from last year’s annus horribilis, Pace investors could be forgiven for being more than a little wary when news emerged of a fresh contract setback for the set-top box giant.

Memories of the three profits warnings, caused by a range of problems including severe flooding in Thailand, the Japanese tsunami and a delayed order from a large United States customer, are indelibly etched in investors’ memories.

So the revelation that Pace has hit a delay in supplying internet TV YouView set-top boxes to BT – which could mean the project is cancelled – sent its shares plunging.

The boxes reportedly failed to meet the telecoms giant’s requirements, forcing BT to switch to Korean supplier Humax. The Saltaire-based firm’s stock shed almost 10 per cent to 162.5p, and still remains below that mark. That’s despite Pace’s insistence that the issue is of “no material impact to the company’s earnings in this or future years”.

It’s thought the business earned low margins and the impact will be well below one per cent of revenues. Sales in the United Kingdom contribute only a fraction of the group’s revenues, compared with Americas which are responsible for about 56 per cent of sales. But Numis Securities analysts still see it as an “incremental negative”. “It suggests there may still be some issues in the actual profitability of new business,” they said.

However, Peel Hunt analyst Alex Jarvis argues the “disproportionate” response to the issue is a buying opportunity.

“We do not believe this is a project management, innovation or resource issue,” he said. “Pace is a strong self-help story in a company with relatively strong revenue visibility.”

Pace has clearly come some way from the shambles of last year, when one analyst notably described its litany of excuses as a bit like “the dog ate my homework”.

Operating costs have been slashed by about $21m (£13m) in the first six months of the year and working capital cut by a third or $59m.

Net debt was down 24 per cent in six months to $243.3m and Pace is also upbeat about its second half.

That progress, and speculation of a takeover, has lifted the group’s shares considerably from their low tide mark of 43.5p late last year.

Sensibly, software and services are a key target for Pace, which is repeatedly reminded by analysts that set-top boxes are becoming an endangered species in developed countries’ modern homes.

In developing markets, where internet connections remain slow and unreliable, set-top boxes will be around for some time to come.

But as Blackfriar has often pointed out, the traditional set-top box risks going the way of the VCR as tech-savvy consumers explore different ways of watching TV and consuming digital media.

Pace has seen this coming, and its purchase of ‘gateway’ or ‘home hub’ maker 2Wire in 2010 for $475m expanded it into developing boxes to link multiple devices in the modern home to the internet.

Numis said while these home hubs are making progress in the US, it harbours concerns about the future prospects of the device. “Given the weak US macro and consumer spend gravitating to smartphones/tablets, we retain concerns regarding future uptake of ‘home-hub’ STBs (which cost consumers about $200/year).”

Faster internet speeds also pose both risks and opportunities. To some, they could remove the need for a physical box. Services such as SkyGo, the broadcast giant’s on-demand media player, allow viewers to plug iPads and laptops directly into TVs to watch content from films to live sport, to some extent negating the need for a physical box.

But to others, they could increase the need for one, convenient device – such as a home hub – to link the myriad of connected wireless devices in modern homes.

Pace will hope it is the latter.

The firm needs a steady run of good news to convince jittery investors.

Perhaps the real benefit of the fourth generation (4G) mobile internet roll-out is the potential it offers rural areas.

MPs recently bemoaned the lack of acceptable broadband across large parts of East Yorkshire and North Lincolnshire.

“Superfast broadband cannot come quick enough to the good folk of East Yorkshire and Northern Lincolnshire,” said Brigg and Goole MP Andrew Percy.

So Blackfriar takes some comfort from the assurance by mobile operator EE that it is not stopping at cities with its 4G roll-out, but will then target rural communities.

Firms have been put off digging up roads to reach small communities with fibre optics for relatively small gain.

But who needs wires and cables? Airwaves are a much cheaper way of reaching rural communities, and as long as mobile pricing is comparable to fixed line, 4G offers a viable alternative.