Is this turnaround stock a falling knife to catch after dropping 30% today?

Telit chip processor

Shares of Internet of Things company Telit Communications (LSE: TCM) plummeted on Monday after it released its half-year results. And they’ve crashed again today, down as much as 55% to 100p at one point this morning.

Today’s rout comes in the wake of an unscheduled statement from the company issued at 7:00.

Fugitives from justice?

Telit stated it “notes speculation regarding historical indictments in the United States of America of Telit’s Chief Executive Officer, Oozi Cats” and that it has “appointed independent solicitors to conduct a thorough review of this matter.”

The company added: “Pending the outcome of this review, the Board have agreed to Mr Cats’ request for a leave of absence from the company. Yosi Fait, Finance Director and President, will serve as interim Chief Executive Officer during this time.”

Court papers from Boston, Massachusetts, published yesterday on the Shareprophets website, show indictments for fraud in 1991 against husband and wife Uzi Katz and Ruth V Katz, both of whom fled the country.

Shareprophets says it’s a remarkable coincidence that Telit’s chief executive Oozi Cats was born the same year as Uzi Katz and that his wife, Ruth Veronique Cats, also shares a birthday with Ruth V Katz.

Bargepole

If it’s more than a remarkable coincidence, does it damage the investment case for Telit? Or is it a great opportunity to pick up shares at a knockdown price? After all, the company said today that these are “matters which are unrelated to Telit and significantly pre-date its establishment.”

As it happens, steering well clear of companies with directors who’ve been investigated for or convicted of any financial wrongdoing was the number one tip in my recent article 5 top tips to avoid losing your shirt on AIM stocks. For me, Telit is a bargepole stock on this basis alone.

However, even after the dramatic fall in its share price, I also view the company as having no appeal on the basis of its financials and valuation.

Dirt cheap earnings multiple

Telit’s shares climbed as high as 360p when it released its annual results in March. These showed it continuing to deliver impressive growth in revenue and adjusted earnings per share (EPS). The latter came in at 26.4 cents (20.3p at current exchange rates), giving a trailing price-to-earnings (P/E) ratio of 17.7 at the time.

The shares are trading at 125p, as I’m writing, so the P/E has now dropped to 6.2. Surely the stock must be dirt cheap on this multiple?

Cash flow is reality

In my detailed review of Telit’s historical and full-year numbers, I discussed the chasm between its impressive paper profits and poor free cash flow (FCF), noting that the company “continually delivers little (at best) or no FCF.” I calculated 5.4 cents (4.15p) before acquisitions, which even at today’s depressed share price gives a sky-high price-to-FCF of over 30. And the forward multiple will be even higher after Monday’s poor first-half results.

So even if I were to assume that the chief executive doesn’t have a prior history of fraud and that a potential area of aggressive accounting (high and rapidly rising capitalisation of costs) I’ve previously noted is nothing to worry about, I’d still continue to rate the stock a ‘sell’ based on it being grossly overvalued on a FCF basis.

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G A Chester has no position in any shares 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.

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