Chinese IPO's on US stock exchanges were hot few years back. Subsequently, the market was rattled by share price slides, delisting of some Chinese stocks and administrative proceedings brought last year by the SEC against the Chinese affiliates of several U.S. accounting firms for not handing over work papers for audits in China. Because of all this, investors now tend to label all US-listed Chinese companies as untrustworthy, but we stumbled upon an interesting company which is clearly not a fraud: Mecox Lane (MCOX). This company is actually one of the biggest e-commerce leaders in China, and its management, unknown to many investors, is rolling out an important turnaround strategy. Its shares took an irrational deep dive though, creating a buying opportunity.
What is Mecox Lane?
Mecox Lane, through its subsidiaries, engages in the design and sale of apparel, accessories, and home and healthcare products through its online platform and stores in China. The main online platform is m18.com. The company sells its products under the Euromoda, Rampage, and various third-party brands through. In addition, the company is involved in the telephonic sale of garments, accessories, and other products; wholesale and retail of garments; and provision of software development and information technology support services. The company was founded in 1996.
Why did the share price fell so much?
Mecox made its debut on the stock market in 2010. The IPO price was $55, went up to $81, but now the price is $4. What happened?
- The IPO price was way too high. Institutional investors, owning large positions pre-IPO, sold their positions accordingly, causing a lot of selling pressure.
- A general fear of fraud by US-listed Chinese companies depressed the stock price.
- A price war raged in China, causing Mecox to incur large annual losses in 2011 and 2012.
- Investors lost attention
But the situation recently took a 180 degree turn. The intense selling pressure caused the company from being overvalued to grossly undervalued. Nobody is paying attention though, as management has begun turning the corner.
No this is not a fraud
Chinese company? Most investors are, probably rightly so, wary of US-listed Chinese companies. But in this case, the fear is not justified. Mecox Lane exists for 17 years now, and as per December 31, 2012, its store network consisted of 316 stores, including 261 franchised stores and 55 directly operated stores in 129 cities. Mecox has more than 2000 fulltime employees. So this is a very real company, backed up by reputable investors like SINA and Citigroup. Also, the short ratio is vanishingly small. We believe the irrational fear of fraud has caused an unjustified low-valuation level.
Investors aren't paying attention
With fraudulent companies, there is often an intense promotional campaign going on. With Mecox, the opposite holds up. There is no analyst covering the stock, and there is hardly any activity on online discussion boards, including this website. This is a micro cap, and smart investors know lack of coverage often causes some degree of mispricing. There was one article published half a year ago though, that drove up the share price by 150%. The same could happen again.
Mecox Lane's balance sheet
Mecox has a book value of $7 and has initiated a cost restructuring program, in order to lower their operational costs. Cash and cash equivalents as of June 30 of this year totaled $7.2 million and restricted cash totaled $17.9 million. Short-term investments was $10.5 million and secured short-term borrowing was $15.4 million. All of which was secured by restricted cash of $17.9 million. Total equity is $89 million whereas Mecox's market cap is currently just $50 million.
A large institutional investor is buying
Mecox is backed up by large institutions, like SINA and Citigroup. Also, insiders like Alfred Gu (CEO) own millions of shares and options. These options have a strike price far above the current stock price. This is all a positive, but last week telling news came out. According to the latest SEC filing, see next pic, a Chinese Private Equity Group (Chaoyong Wang) is accumulating shares. Their stake now is 7.14%.
This is a major endorsement. We wonder if somebody else noticed this.
A turnaround strategy is unfolding
Management has begun rebranding their product mix this year, scaling back low-margin business activities and scaling up high-margin business activities. Combined with the cost restructuring program and a softening price war, we believe the fruits of their labour will be noticeable in 2014 as a well performed execution of the new strategy will highly likely make Mecox Lane a profitable company again.
Their CEO stated:
"Looking forward, we will remain prudent with regards to our cost and cash expenditures and we will continue to make efforts to position ourselves as a multi-brand and multi-channel fast fashion apparel company."
Rebranding is the right step as their Tmall.com project proves.
" Although our e-commerce continued to be negatively impacted by the transformation of M18.com to a non-exclusive, multi-channel platform, we saw increased sales on independent e-commerce platform such as TMall.com in the second quarter."
Upside potential is huge as Mecox is operating in a massive market. Online retail in China is a fast growing business, even with the slow-down of the economy this year. This is a multi billion dollar industry. Revenue of Mecox in 2012 was $150 million. Market cap is just $50 million. A price-to-sales ratio of 0.33 is very cheap. Besides profit, a well executed strategy could significantly increase revenue as well, and thereby drive up the share price by at least 100%. Shares of Mecox Lane doubling is not an uncommon occurrence as this already happened twice this year.
Low volatility provides great entry point
Mecox Lane's shares were always volatile, but in the last 2 months, the share price is in calmer waters.
Shares trade nicely above the MA(50) and MA(200) support levels. From a technical point of view, Mecox Lane now offers a great entry point to accumulate a position.
Shares of Mecox Lane are grossly undervalued. Management has initiated just the right steps to ensure the company becomes profitable again. Upside potential is enormous, as Mecox Lane operates in a clear-cut multi billion dollar market. Investors are probably holding back because this is a Chinese company, but this fear is overdone. The solid balance sheet ensures downside risk remains limited and now a large institutional investor is accumulating shares, we think now is the time to buy shares of Mecox Lane as well.
Recommendation: Strong buy, price target $10.
Ticker code: MCOX
Market capitalization: $50 million
Average daily volume: 257K
Next earnings date: 18 November, 2013