Strong Revenue and Profit Growth
CDC achieved strong financial performance in 2Q2006. Revenue increased by 19.2% to $77 mn, while net profit grew sharply to $7.90, compared to $1.48 mn in 1Q2006. 61.9% of QOQ incremental revenue came from 17game shareholding increase. On March 23, china.com (HKSE:8006), a subsidiary of CDC, increased its shareholding of 17game from 48% to 100%, so that CDC can fully consolidate 17game’s revenue of $7.7 mn in 2Q.
Growth Is Sustainable
However, interest holding increase was not the only reason for Revenue growth, most of other segments performed organic growth well. Software revenue, the largest segment, rose by 6.7% QOQ in 2Q2006. Business services revenue increased by 15.7%, while mobile revenue increased by 12.8%. Only advertising revenue suffered a decline, but it was the least important to total revenue. Classified by subsidiaries, CDC Software revenue increased by 8.9% and china.com revenue excluding online game increased by 0.1%.
Further, online game, the newly consolidated segment, is not a one-off revenue driver. 17game revenue was HKD40 mn in 1Q2006 and HKD61 mn (equivalent to USD7.7 mn) in 2Q2006, which suggest a 52.5% QOQ growth rate.
Operating Expense Optimized
In 2Q2006, Operating expense increased by 11.1% QOQ, back to over $36 mn, but operating expense to total revenue percentage declined from 51.0% in 1Q to 47.5% in 2Q. After consolidation of online game business, absolute increase of operating expense is inevitable, while the decline of operating expense percentage proved further the improvement effect of online game business to profit margin.
Proposed Acquisition of Timeheart
In an August 18 announcement, CDC proposed to acquire 100% equity of Timeheart, a mobile value added service [MVAS] provider, for $25.4 mn. The agreement between CDC and Timeheart is subject to the approval of shareholders. CDC stated that Timeheart earned a profit of $3.5 mn in 2005, but we believe Timeheart’s profit in the first half of 2006 suffered a HOH decline for tough policies from China Mobile (NYSE:CHL). However, we do not mean the acquisition is a mistake, on the contrary, we believe size does matter for service providers [SP] to survive the hard time.
Good to Quit Hostile Acquisition
On July 25, CNC announced that it terminated tender offer for all stocks of Onyx Software Corp. (Nasdaq:ONXS) We are happy to see the quit, because we believe a hostile acquisition is a hostile acquisition, which is always costly. Repeated in almost all Onyx-related announcements, CDC condemned that anti-takeover techniques, like poison pill, reflected Onyx’s management interests rather than shareholders wealth. But we believe a time consuming combat and a rising offer price are not good to CDC shareholders either.
Another Stock Repurchase Program
On May 2, CDC announced to extend 2005 stock repurchase program and proposed to buy back $20 mn common stock. Three months after, on July 26, CDC announced $19.3 mn stock had been repurchased. Further, another $20 mn repurchase program was launched for 12 month until July 2007.
CDC added two repurchase programs and completed one program within three month. We believe all these reflect strong management confidence on financial performance in the future. Additionally, we believe that repurchase program is much better to CDC investors than a hostile acquisition like Onyx case, when a company tries to lower cash balance.
Valuation and Recommendation
Based on segmental analyses above, we assume revenues of online game and business services will grow strongly in the coming two quarters and slowdown in 2007. We also assume that software revenue as the most important income will grow stably by 2% QOQ until 4Q2007. Another assumption is mobile services revenue will increase by 8% in 3Q and 4Q for the acquisition of Timeheart, and suffer stagnancy in 2007. We believe operating profit will rise sharply in 3Q, because CDC must continue to reduce cost after consolidating operating expense of the online game business. We would like to maintain our BUY recommendation.
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