Try the new FT.com

September 11, 2006 6:55 pm

James Altucher: Nasdaq’s ‘magic’ Chinese offers

  • Share
  • Print
  • Clip
  • Gift Article
  • Comments

The other day I was in a meeting to look at a private Chinese internet company. Two other hedge funds were also in the conference, organised by a rogue banker from an investment bank.

The others were multi-billion-dollar funds that had participated in several China-related initial public offerings. The deal was phenomenal – great cash flows, great value per subscriber, huge potential for growth and so on.

And why not? Everywhere you go in China there’s huge potential for growth. You can pass 78m people simply by crossing the street and everyone is turning into a capitalist. One of the funds kept asking, “why are we getting ‘the magic deal’? This is the ‘magic deal’!” He kept repeating that phrase.

I became infected by his enthusiasm and started thinking in those terms as well. Why would we get a magic deal? The company said: “Because that’s the way things are right now in China.” And it’s true.

There are more than 123m internet users in China and that will multiple by three or four before the end of the decade. Eighty per cent of present users are under the age of 35, so it is still largely a universe of early adopters, particularly as broadband is only beginning to roll out though the cable companies. If China can continue to have anywhere near its 10 per cent growth in gross domestic product, the rise in every area of internet usage will be maintained.

But you don’t need to go to China to find the “magic deal”. The Nasdaq index has several Chinese internet companies worth looking at. All have potential for acquisition in the next six months because their stocks have been slaughtered for what I believe are largely irrational reasons. One is Beijing-based Kongzhong Corporation.

Here are two that look interesting. Netease operates an online and wireless community inside China. Its services include online games, wireless services and internet portals. Its online games business, like Shanda Interactive, consists primarily of massive multiplayer online roleplaying games. The company makes money by selling prepaid cards that are based on points. Customers spend those points on games provided by the company. Its value-added wireless segment provides short messaging services that allow users to receive their stock quotes and download ringtones and logos for their mobile phones.

Netease has an excellent balance sheet with more than $3 a share in net cash. In addition, the stock is extremely cheap on the ratios when compared with growth – a ratio of enterprise value to earnings before interest, tax, depreciation and amortisation of 15, and an earnings multiple of 22. Revenue has grown significantly from $221m in 2002 to $1.8bn in the past 12 months. And earnings before taxes and unusual items have grown from $51m to $1.18bn in the same period.

Netease is also expanding its returns on capital and assets. For example, it has grown return on capital from 14 per cent in the 2004 financial year to 34 per cent in the past 12 months. The company has also grown return on assets from 13 per cent in the 2004 financial year to 21 per cent over the past 12 months.

The market has been generally bearish on China stocks in the past six months and Netease has fallen from a high of $25 to about $17 today. But the company is not as bearish as the market, and two weeks ago it announced it would be buying back $100m worth of shares – not so hard to do considering it has $454m cash in the bank and zero debt.

Another stock is Hurray, which provides music-related content over mobile-phone networks. It also provides value-added services such as games, pictures and animation. Its short-message service include cartoons, mobile novels, local news and stock quotes.

I think this company is the most undervalued in this space at seven times earnings, and about three times enterprise value/pretax earnings excluding unusual items. It has a 20 per cent free cash flow yield. In addition, you get a stellar balance sheet with $78m in cash. Like others, the company has been hit by news that China Mobile is changing the way it bills subscribers. But Hurray has a more diversified revenue stream, being also in music publishing and distribution and record label business. With its balance sheet and strong cash flows it can weather any storm.

So you don’t need to go to China and look behind random beanstalks or deep in forbidden caves to find magic deals. Those deals can be found on Nasdaq.

james@formulacapital.com

Copyright The Financial Times Limited 2017. You may share using our article tools.
Please don't cut articles from FT.com and redistribute by email or post to the web.

  • Share
  • Print
  • Clip
  • Gift Article
  • Comments

NEWS BY EMAIL

Sign up for email briefings to stay up to date on topics you are interested in

SHARE THIS QUOTE