Tuesday, December 15, 2009

Telestone Technologies (TSTC) - Small Cap Chinese Telecom Equipment Maker; Some Services to Boot

Much like SmartHeat (HEAT) which we mentioned at the beginning of the month [Dec 3, 2009: IBD - SmartHeat: Heating Equipment Maker Benefits as China Spends to Clean its Air], there are quite a few small-ish cap Chinese stocks flying almost every day.  Many are the "same old, same old" names that ran in 2007 and first half 2008 (especially in alternative energy, or solar) chock full of momentum traders, but there are some other interesting companies surging. One potential story is Telestone Technologies (TSTC) which might be a (very) poor man's Starent Networks (STAR) [an old holding of ours, bought up by Cisco)  Website here.

Telestone provides Local Access Network Solutions, products and engineering integration to telecom carriers. In terms of 2G technologies, Telestone is a main supplier in wireless access coverage infrastructure building for the GSM and CDMA network base on its RFPA technologies primarily in the PRC. The products; repeaters, line-amplifiers, antennas and radio accessories are all based on RFPA technologies.

After intensive research on the demands of carriers in 3G technologies, based on its strong R&D capabilities in both wireless and Fiber-Optics, Telestone has invented its WFDS unification local access network solution and products which are highly welcomed by all telecom carriers and property owners. Telestone also provides services that include project design, project manufacturing, installation, maintenance and after-sales services. Telestone currently has approximately 1,200 employees.

Anything that touches "3G" or the comimg "4G" I am interested in... Chinese alternatives even more compelling.  Thus far the bread and butter business has been 2G, so the risk factors is obviously technological migration - but it seems to be doing something right.  At just under $200M in market cap this is smaller than my usual fare, but its quarterly revenue amount is large enough to consider... although it's touchy.  However, the revenue growth percentage is off the charts, and the shares outstanding (10.4 million) are very low (allowing great EPS growth) so combined with the stock movemenet - hard to dismiss.

This name has only been on my radar since mid November, but already its jumped from $11 to $17 - in this market those who don't buy, lose.  You can see it's actually tripled since early fall.

[click to enlarge]

Below we'll look at both the latest earnings report and a nice introductory piece at TheStreet.com.

November 12th earnings report

  • Revenues for the third quarter ended September 30, 2009 increased 124.7% to $18.9 million compared to same period of 2008. Telestone revenues are a combination of equipment and service sales.
  • Equipment sales, which totaled $11.1 million, are attributed to the Company's shipments of its proprietary 2G and 3G local wireless access network equipment, manufactured for specific customer site installations.
  • Service revenue, which totaled $7.8 million, is a combination of billable system integration and installation charges by Telestone's project design and implementation engineers.
  • Total revenue growth for the quarter was directly attributed to the Company's sales of 2G and 3G network installations throughout China.
  • In addition, a growing contributor to the Company's revenues is its Wireless Fiber Option Distribution System(TM) (WFDS(TM)) which accounted for about 20% of Telestone's revenues for the quarter. WFDS(TM) systems provide "multi-play" capabilities for media, voice, fax, closed circuit TV, data and all three protocols of Chinese cellular signals over a fiber optic cable routed directly into an installation site. WFDS(TM) is a certified-technology by the three Chinese telecommunications companies; China Mobile, China Unicom and China Telecom, and was recently approved by the FCC of the United States in September of this year.

Cost of Goods; Margins
  • Costs of goods sold were $10.0 million in the third quarter of 2009 which yielded gross profits of $8.9 million. Costs of goods are comprised of components used in the manufacturing of Telestone's 2G and 3G product line and installation costs of project management and labor costs at commercial and residential customer locations.
  • Specifically, cost of equipment sales totaled $7.1 million, yielding gross margins of 36.0% while cost of services totaled $2.9 million, yielding gross margins of 62.8%. Blended gross margins were 47.2% compared to 46.9% for the third quarter of 2008. 
Operating Expenses - dropping nicely
  • Total operating expenses for the quarter were $3.3 million, or 18.0% of revenues. Third quarter operating expenses as a percentage of revenues decreased 9.20 percentage points compared to the same quarter in 2008. The decrease in percentage for operating expenses is primarily due to the fact that expenses are rather fixed in nature. As a result, operating income increased 223.6% to $5.5 million in the quarter compared to $1.7 million recorded in the third quarter of 2008.
Taxes - large benefit for 3 year period due to type of company it is; something the US could learn from; 15% go forward
  • Telestone maintains a 24% effective income tax rate for the quarter. However the taxes paid in the third quarter were not only for the net income in the quarter, but also including taxes due in previous quarters. As a High and New Technology Enterprise in China, the Company expects its income tax rate to be 15% for a three-year period.

Net Income:
  • Net income for the third quarter ended September 30, 2009 increased 281.8% to $4.2 million compared to $1.1 million in the third quarter of 2008.
  • Net income margins for the quarter were 22.5% compared to 13.3% recorded in the third quarter of 2008.
  • Earnings per share were $0.41 on 10.4 million fully diluted shares issued and outstanding, an increase of 272% compared to $0.11 reported in the third quarter of 2008.
The balance sheet is quite interesting with days sales outstanding apparently over 400 before some corrective actions - I've never heard of such a high number before.
There appears to be no analyst coverage... so I guess I will be it for now.

Nice overview of the business at TheStreet.com from a guest author in October 2009.
  • Telestone Technologies (TSTC) provides 2G and 3G wireless communication access coverage solutions to telecom companies such as China Mobile (CHL), China Telecom (CHA) and China Unicom (CHU) through its branch offices in China across 26 provinces.
  • The Chinese government will spend $70 billion over the next three years on 3G initiatives. This creates both visibility and acceleration in TSTC's business.   TSTC has aggressive goals over the next two and a half years to increase its domestic market share from 5% to 33%, indicating that it intends to capture a good deal of government-allotted spending with its new WFDSTM technology.
  • International business accounts for less than 5% of TSTC revenue. TSTC plans to expand its operations in the U.S. and other developed markets with its WFDSTM technologies, while serving those that are underdeveloped and behind the technology curve with its mature 2G technology to extend the life cycle of its 2G products.  (any large scale foreign wins would be huge for credibility, especially considering how small the company is - until proven otherwise let's dismiss this)
  • In simple terms, the WFDSTM platform allows all aspects of a client's wireless and wired needs to be addressed as one comprehensive solution. WFDSTM has become more significant since China began granting third generation (3G) licenses during the first half of 2009. 3G systems put greater technical demands on the communication networks in buildings due to signal strength and frequency -- demands that WFDSTM can handle much more effectively than traditional wired and wireless solutions.
  • Currently, TSTC is the only Chinese company offering a WFDSTM type platform. Even as competition enters the market, Telestone has a significant advantage because customers will likely be hesitant to switch to another provider with unproven reliability. Telestone believes that customers will gravitate to its services as the advantages it offers have the huge potential to save time and money.
  • TSTC has issued 2009 guidance of $70 million in revenue, up 100% year over year. Based on its 2009 first-half performance, we assume TSTC can minimally maintain 17% net margins, implying an EPS figure of $1.14. (15% tax-rate assumption). Our EPS assumption is likely conservative, as Telestone's annual after tax margins are typically around 20%.
  • As we followed the Telestone story for a couple of years, we witnessed the stock's peaks and valleys. However, it appears that the company finally has an opportunity to take a nice leap to the next level of growth -- an opportunity that we feel was hampered by the delayed launch of 3G in China, ultimately forcing customers to postpone spending.
  • With the 3G launch out of the way, it appears that one more hurdle is impeding Telestone's progress. The company has been experiencing accounts receivable collection delays as a result of multiple factors including timing of capex and effective live network dates in addition to massive industry consolidation that occurred during the past year to create the big three providers of today.  (that explains the crazy high DSO I mentioned above)
  • Per Telestone's 2009 second-quarter filing, operating cash flow is negative, although it balances annually. We are hopeful that increasing sales and improved collections will resolve this issue.
No position but wish I had....

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