Friday, August 7, 2009

Niche Play on China Telecom: AsiaInfo Holdings (ASIA)

At heart I enjoy finding longer term secular growth stories and investing accordingly; unfortunately the world is not exactly awash with them since most developed countries seem to be relying on bubble creation for prosperity, rather than actual paradigm changing innovations. Plus with almost every stock moving together in "student body" left trading for the better part of 18 months individual stock selection has meant little. However if we ever return to a more normal market, something that is catching the fancy is the mobile internet - which we've been talking about for quite a while. Basically repeating the late 90s thesis, but "in the air" rather than "by landline"- hopefully without v2.0. A related secular growth story is the telecom buildout & modernization in China. Even as I am wary of the conditions created by the massive loan growth in that country - which are affecting real estate, stock market, and commodities; I think the telecom modernization is the real deal. Now if China corrects seriously will this secular growth story matter? No - not one bit... student body trading morphs into "baby out with the bathwater" once the music stops. But we still want to develop lists of interesting ideas to which to wrap the intermediate to longer term portion of the portfolio around.

I've had AsiaInfo Holdings (ASIA) on 1 of my "to do" lists to research for 6 months now and only in the past 2 weeks have created some time to actually dig into it. This is a $800M market cap company, growing at a stellar rate, profitable, no debt, reasonably valued unlike much of the nonsense being run up at 50, 60, 80x forward estimates. In other words it is not that fashionable of a stock to buy - much hotter are unprofitable, very expensive, and debt laden. But we'll stick to our knitting. Their website is here, and a good overview of the company via .pdf file can be found here. Specific info on their product lines here.

Interestingly enough, this company was actually founded in Texas in the early 90s but by 95 had essentially moved most major operations to China. Much like the niche telecom players in the US, the company is reliant on a small cadre of big telecom service companies (i.e. in the US these would be the Verizon's, AT&Ts et al) so this creates both a blessing and a curse.

AsiaInfo Holdings, Inc. (Nasdaq: ASIA) is a leading provider of high-quality telecom software solutions and IT security products and services in China. In the telecom market, our software products and services enable our customers to build, maintain, operate, manage and continuously improve their communications infrastructure and services. Our largest customers are China's major telecom carriers: China Mobile, China Unicom and China Telecom. In addition to providing telecom software solutions and services, we also offer sophisticated IT security products and services, such as firewall and Virtual Private Network (VPN) products in China.

I ran the name past Zach of since we generally have similar taste in "themes" and stock ideas and after a cursory look he also found the company attractive. He was interested enough to do a lot more digging and has provided us with another excellent write up. Now in great irony, since we've been trading commentary back and forth via email the past few days on this company - the stock has done nothing but go down.

Technically there is a little gap around $17.60s and the 50 day moving average is around $18.30. So I've been waiting to see how the stock acts if and when it fills the gap. To the topside it has been struggling at the $20.50 area so for now it appears range bound - also negative is that recent highs have been lower than early June highs. Therefore this stock would not be attractive to the current "momo" crowd (buy high, sell higher - valuation means nothing) which is dominating the stock market right now. I would love to be a buyer down near the 200 day moving average ... but I suppose that would require the stock market to fall. So we can't count on such an improbability such as that. (ahem)

From there, I'll let Zach go in more depth on this idea that I believe will be joining our portfolio in the future.

Guest Post from Zachary Scheidt – Zach manages which focuses on uncovering investment opportunities in growth stocks – trading from both the long and the short side. Zach also is the Principal and Chief Investment Strategist at Sound Counsel Investment Advisors – a boutique investment company which seeks to provide independent investment advice to individuals while minimizing conflicts of interest or biases which are typically represented at larger investment firms.

AsiaInfo Holdings – An Attractive Value in the China Telecom Market

It seems that in today’s market, any stock associated with China is bound to be trading in a positive trend. It’s no wonder as the Chinese equivalent of our Federal Reserve Board has made it clear that the country will continue to keep monetary policy loose in order to foster growth. The policy has driven investors to bid up stocks in a seemingly endless parade of capital, regardless of the price.

While all too many Chinese companies are now trading at multiples that are similar to the Internet bubble of the late 90’s (and we all know how that turned out), there are a few growth opportunities in China that actually trade at a reasonable price. Picking up a Chinese growth stock in the neighborhood of 20 times earnings not only gives you the chance of experiencing multiple expansion (imagine the price of the stock if it rose to 30 times earnings), but if you pick your candidates correctly, you should see upward revisions to the earnings expectations which can compound gains.

Today there appears to be an attractive opportunity in AsiaInfo Holdings Inc. (ASIA). The company is one of the leading telecommunication companies in Mainland China and offers software and solutions, as well as IT security products and services. ASIA is actually broken into two separate business divisions:

  • AsiaInfo Technologies
    This division offers traditional telecom software and solutions to telecommunication carriers. The division is broken into three primary categories which include Business Operation Support Systems, Service Application Systems, and Network Infrastructure Solutions. If all of that sounds like alphabet soup from the '90's, you can boil it down simply by saying that ASIA partners with carriers to help with processes like efficiency, connectivity, billing, and customer care.

  • Lenovo-AsiaInfo
    The Lenovo division could actually be compared with Mcafee Inc. (MFE) or Symantec Corp (SYMC). With expertise in IT security, antivirus and other network protection technologies, Lenovo has built a reputation for security. Landing contracts with the Chinese government is certainly a ringing endorsement of the divisions skill in protecting customers.

Although both divisions are showing significant growth, the first business line actually accounted for 83.7% of revenue in 2008, and for the first two quarters of 2009 that level has actually been closer to 90%. Still, Lenovo could eventually morph into a much larger portion of the company’s business as cross-selling opportunities emerge. Lenovo has also landed quite a few recent contracts with government agencies. If the company manages these contracts well, it is easy to see how business could pick up substantially.

AsiaInfo is actually a bit constrained as to who it can deal with when it comes to landing new contracts. In the most recent quarter, management noted strength in “all three major customers” in the telecom business. These three players are China Mobile, China Unicom, and China Telecom. The existence of three major semi-state-owned players as the primary customers can offer investors both risk and stability. Obviously diversifying to more than three primary customers would reduce risk as no one damaged relationship would be as material to long-term earnings.

But at the same time, as ASIA makes inroads and establishes a reputation with the major players, investors can be confident that the major customers will be able to pay invoices and will likely represent a long-term growing relationship as China’s population increasingly moves toward a higher quality of life with more services demanded.

Looking at the most recent quarter, ASIA exceeded revenue and earnings guidance and offered some very positive commentary. To quote Steve Zhang, AsiaInfo’s president and CEO,
“[the company]… Continues to benefit from increasing expenditures on telecom software, as operators build out and further optimize IT infrastructure and integrate fixed line broadband and mobile businesses to provide bundled service offerings.”

Revenue for the quarter came in at $58.6 million which was an increase of 39.3% over last year and 14.9% from the first quarter. Earnings were posted at $0.25 per share which was nearly double the 13 cents earned in the second quarter of 2008. And most impressively, profitability metrics improved with gross margin coming in at 49% compared to 45% last year. The higher margins is a direct result of the company selling more software which has better profitability than hardware products.

While we have discussed the “three major customers” as pseudo government agencies, ASIA was able to land seven new contracts with subsidiaries of these customers which gives a bit more diversification to revenue streams. These contracts were primarily to upgrade business intelligence systems as China Mobile rolls out its expanding 3G network.

On the security business side, there were several key contracts signed with government agencies, but as you can imagine very few details were given.

AsiaInfo has a strong balance sheet with no debt and unrestricted cash of $177 million. The cash balance is up from $172 million at the end of last year which proves that even as the company invests in future growth, it is able to retain a good portion of its earnings. At some point investors will likely begin to ask management to do something productive with the cash, but for today I prefer to hold stocks that have given themselves financial flexibility and have no risk of missing debt payments or falling behind on debt covenants.

Analysts are expecting ASIA to earn $1.05 next year which means the stock is trading at just below 20 times forward earnings. That price is not exactly cheap, but compared to many other Chinese stocks that are showing similar growth – it is a “relative value.” With a strong management team, proven success in landing contracts, and a fiscally conservative approach to growth, this stock appears to be a worthwhile investment with a very attractive potential return.

No position

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