Qiao Xing Mobile (NYSE:QXM) is a holding company which conducts its business through CEC Telecom, or CECT, an operating unit located inside the People's Republic of China (PRC). The company is one of the largest domestic makers of cell phones in China, where effectively all revenues originate from.
The company sells under two brands: "CECT" is the legacy and low-end brand, while "VEVA" is a high end, smartphone-like brand launched last May. The majority of units are sourced through third party manufacturers, although a fair number (15% in 2007) were self-manufacturedץ. This figure should rise as QXM opened a new plant in January of last year. In all, Qiao Xing sold about 3.8 million handsets in 2007, the last full year of data.
Three Points of Investment
Let's take a look at Qiao Xing using the 3 points of investment, and then detail some specific risks. First, the growth picture:
I've given Qiao Xing a C+ for growth potential. The Chinese mobile phone market is one of the most attractive in the world for several reasons. First is a low penetration rate, which should rise given China's universal service mandates for telecom providers and the fact that those living in small cities and rural areas are benefiting from the country's emerging economy, giving them the chance to purchase items like cell phones for the first time. When you apply these factors over a population exceeding 1.3 billion people, it's clear that the mobile phone market there will grow at attractive rates for the foreseeable future. iSuppli estimates nearly 8% growth in 2009 to about 239 million units, a good growth rate with clear and substantially more growth possible (China Mobile (NYSE:CHL) has over 600 million subscribers alone).
This new adoption demand is also buttressed by replacement demand to higher end phones (as in most developed economies), taking advantage of emerging technologies like 3G data networks and touch screen phones. Qiao Xing's VEVA line is poised to benefit from this. Growth is tempered by competitive concerns, however, which will be detailed below.
The second point of investment is financial health:
Qiao Xing looks in pretty good shape here, with 2.9 billion yuan in cash (about $425 million USD) to 1.2 billion yuan in debt ($175 million USD). Most of this is in short-term notes, not really the most desirable way to finance a business. Short-term rates are higher and the debt is due in the near-term... As a result Qiao Xing's interest coverage ratio is less than great at just 7x. This looks a bit risky given the volatility in the discretionary business of cell phones, but current ratio is comfortable at nearly 3.
Return on capital is very good, at a normal rate in the mid-30%, and a Magic Formula rate of 51%. Free cash flow margin in 2007 was 27%, but likely lower in 2008. One thing that has been improving is operating margin, as the company focuses on higher end products - it has risen from 21% to 39% in just the last 4 reported quarters. The focus on VEVA is paying off here.
Last is competitive moat, and here we run into a big fat problem:
Consider this: in 2007, Qiao Xing sold about 3.8 million units. By comparison, Nokia (NYSE:NOK) sold about 71 million units. Other big cell phone makers like Motorola (MOT) and Samsung (OTC:SSNLF) also have targeted China for growth. VEVA, Qiao Xing's future, faces established smartphone competition from Apple (NASDAQ:AAPL) and RIM (RIMM), as well as Nokia. With such a small footprint and limited financial resources, it will be very difficult for Qiao Xing to maintain its margins and grow at the same time given the competition and their scale advantages.
The biggest risk here is the short-term debt combined with a volatile market littered with bigger competitors. Like many small Chinese firms, Qiao Xing is tinged with rumors of accounting inconsistencies. This is easy to understand when Q4 2008 results have still not been reported to this day, nearly 4 entire months after the end of the period. While the focus up-market with VEVA has so far paid off, I'm not sure how long it will continue, especially if Apple finally gets into China.
All of this said, MagicDiligence still is intrigued by Qiao Xing given its nearly incomprehensibly cheap valuation. At $2.65 US per share, the market value is about 18.10 yuan/share, a market cap in yuan of 847 million. Yep, that's about 200 million yuan less than net cash on hand! Creating the enterprise value by subtracting excess cash and adding debt, the valuation is negative 668 yuan - MagicDiligence has never analyzed a stock with negative enterprise value before! In essence, the market is valuing Qiao Xing's ongoing operations at under 0.
If the picture still isn't clear, the stock sells at under 1/3rd of tangible book value. In Ben Graham's world of cigar butts, it doesn't get any "butt-ier" than this! If you believe the company can survive amidst the competition, this is a no brainer. I won't recommend it for the MagicDiligence Top Buys list, but if price is your primary investment criteria, it doesn't get any cheaper than this.
Disclosure: Steve owns no position in any stocks discussed in this article.