David Riedel of Riedel Research Group recently published a report on Chinese company CDC (CHINA). The report suggested that investors buy the stock following reported quarter over quarter profits of 41.8% for 1Q'06. Exerpts follow:
CDC management expects net profit in 2Q2006 to range between $5.8 mn and $6.3 mn, 4 times of that in 1Q2006. Net profit margin in 1Q2006 is 2.3%, compared to 1.7% 4Q2005, while CDC suggests profit margin in 2Q2006 will range from 8.1% to 8.9%.
All business lines enjoyed YOY revenue growth in the first quarter, but on a QOQ base, only business services (maintenance) had a growth of 33.4%. CDC announced that its maintenance retention rates exceeded 90% -- higher than the industry average of 85%.
CDC made their best effort to cut operating expense, and as a result operating expense decreased when revenue increased. On May 2, CDC decided to extend the period of the stock repurchase program to May 2007.
With sufficient cash, CDC launched an acquisition schedule named Franchise Partner Program. We calculated a target price of $4.93, which is 9.5% higher than the current market price. Considering parameters from CDC management, the target price might be more aggressive.
Stock Repurchase Program
On May 2, the Board of Directors approved the extension of 2005 stock repurchase program. The program authorized the repurchase of up to $20 mn of the Company’s common shares for an additional 12 months until May 2007.
CDC also announced that the Company purchased over 1 mn shares, in which senior management have bought over 440,000 shares during the last three months. The repurchase plan reflects the confidence of management for future performance and also provides a stock price guarantee to investors.
Franchise Partner Program/Other Acquisitions
On April 18, CDC announced a Franchise Partner Program. In the program, $20 mn will be invested into channel partners, especially those in Eastern Europe, Middle East, Latin America, India, and China.
On April 26, 2006 the Company announced completion of the acquisition of Atlanta-based c360, a customer relation management solution company. The acquisition will be paid half in cash and half in stock in three years. It is CDC's third acquisition in 2006.
We note that, equipped with a large amount of cash, CDC keeps its acquisition strategy for levering revenue. However, acquisition is never immune from risk, so we would prefer to see organic growth.
Valuation and Recommendation
We assume business services revenue will grow by 30% QOQ in 2Q2006 and that the growth rate will drop 5 percentage points quarter after quarter. We also assume revenues from software, mobile and advertising business will rise by 2% QOQ. We calculate net revenue of $69.5 mn, close to the low limit of CDC’s expectation, $70.6.
However our projection concludes a net profit of $3.7 mn -- significantly lower than the company’s outlook of $5.8 mn - $6.3 mn. We believe there is not enough room for cost cutting to make a profit of $6 mn except involving discontinued operations, like sales of assets. If revenue grows stable in the future, asset sale may not be bad news for investors.
Assuming cash flow increases by 10% in 2007 and the increasing rate drops by 2 percentage points thereafter, we calculated a target price of $4.93, which is 9.5% higher than the current market price. Based on the current market price and our conservative earning projection, P/E at the end of 2006 will be 31.6X and P/E at the end of 2007 will be 24.7X. If the CDC expectation comes true, P/E should be lower.
Considering continuous financial recovery and the optimistic anticipation of management, we rate CDC a buy.
CHINA 1-yr chart: