Why I'd dump this turnaround stock after its share price halved in a month

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Telit chip technology

Over the past month, shares in former AIM darling Telit Communications(LSE: TCM) have crashed by around 53% as the company lurched from one disaster to another. 

Telit has been the target of criticism for some time. Even though the firm's pre-tax profits and earnings have surged by around 300% over the past five years, the company has generated almost no cash from operations. Rising profits but a lack of cash is usually a tell tale sign that earnings are being artificially inflated (the company has changed auditors four times in the past seven years). 

Indeed, last week the company reported that it had lost $7m in the first half and had negative cash flow from operations of $3.3m. What's more, it has recently become apparent that the £39m the firm raised from shareholders at the beginning of May, originally earmarked for acquisitions, has been used for working capital. This is yet another sign that the business is not as healthy as management would like shareholders to believe. 

Management problems 

Aside from the financial issues, Telit now has management problems. Last week, chief executive Oozi Cats was accused of being a fugitive from US justice, and rather than fight these accusations, Cats has gone into hiding. 

Today, shares in Telit are rising after the company announced that it had cut ties with Cats, saying: "It is a source of considerable anger to the board that the historical indictment against Oozi Cats was never disclosed to them or previous members of the board and that they have only been made aware of its existence through third parties."

The news release also detailed the company's plan of action of rebuilding the senior management team. Yosi Fait will continue as interim chief executive and the group is looking to hire three new independent directors "as soon as practicable," one of whom will become chairman.

Actions to reorganise Telit's board may have stemmed the bleeding, but I'm not buying into the company after recent declines for several reasons. Firstly, even after falling 50% in a month, shares in Telit are still not cheap. The shares trade at a forward P/E of 15, which might be acceptable if I could trust the earnings, but considering recent revelations, that's almost impossible. 

Secondly, as Telit is bleeding cash, analysts are now starting to ask for how much longer the company will remain solvent. Historically, the group has relied on shareholders and capital markets to meet its cash demands, but now the risk has increased significantly, it's likely potential creditors will demand harsher terms. 

And thirdly, it's going to be difficult ever to trust Telit's management again. Even though the company is trying to put this episode behind it, the group's corporate culture seems tainted. 

The bottom line

So overall, even though some investors might be tempted to buy shares in Telit after recent declines, to me the company looks uninvestable, and the shares could still have further to fall. 

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Rupert Hargreaves 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.