Why I’d avoid trying to catch this falling knife after today’s 15% slump

Troubled Israeli tech company Telit Communications (LSE: TCM) just can’t catch a break. In August, it was thrown into crisis when its CEO, Oozi Cats was reported to be a fugitive who had fled the US back in the early 1990s after being indicted for fraud. Shares in the firm dived on the news and have since struggled to recover. Year-to-date the stock has lost 41%. 

And today shares in Telit are falling once again after the company issued a profit warning and announced several key management changes. 

All change 

After the Cats saga, Telit has decided to shake up its management team. Interim CEO Yosi Fait will now become the group’s permanent leader and the former chairman of gambling group 888 Holdings, Richard Kilsby has been confirmed as the new non-executive chairman. Meanwhile, COO Yariv Dafna has been appointed as finance director. 

Telit’s new management is committed to “applying the highest standards of corporate governance and transparency across the group,” according to Kilsby, which should come as a relief to investors as it now looks as if the company is trying to draw a line under its disastrous past. 

Unfortunately, these positive board changes were accompanied by a profit warning from Telit. The company has already lowered expectations this year, cutting guidance in September due to tougher than expected trading. Full-year revenue guidance was slashed to between $390m and $400m and earnings before interest, tax, depreciation and amortisation to $44m to $48m. These figures were significantly below the EBITDA figure of $54.4m reported for 2016. 

Today the firm announced that it expects to report results for 2017 “materially” below this guidance thanks to pressure on gross profit margins as it transitions from mature technologies. 

Fallen angel 

Over the past few years, Telit captured investors’ imaginations as the company’s exposure to the fast-growing internet of things market (IoT) gave it enormous growth potential. Indeed, only a few months ago, analysts were expecting the company to report bottom line growth of 68% thanks to higher demand for its products. 

However, while some investors have been mesmerised by its explosive growth, analysts have expressed concern about the company’s cash generation or lack of it. 

For example, even though net income has risen from £4m in 2012 to £17m for 2016, over this period the company reported a net cash outflow of £18m. Debt and shareholder cash has filled the gap. Earlier this year, the firm raised £39m by way of a placing and since 2012 total debt has risen by a third. 

This is why I’m staying away from Telit. Even though the company’s net income has multiplied over the past five years, the group has struggled to generate a positive free cash flow. 

In business cash is king, and without cash, it’s only a matter of time before the company will have to raise new funds from investors. Overall, Telit’s new management might be committed to restoring the firm’s reputation, but until the group starts to generate cold hard cash, I’m happy to avoid it. 

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Rupert Hargreaves owns no share mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.