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(Editors' Note: This article covers a micro-cap stock. Please be aware of the risks associated with these stocks.)

Overview:

  1. Over the past five years, Kingtone Wirelessinfo Solution Holding Ltd (NASDAQ:KONE) hasn't grown revenues, and earnings have swung from positive $5 million to negative $5 million.
  2. Recent earnings were a HUGE MISS! Management expected the company to lose between $1 million and $1.8 million, but the net loss came in at $4.5 million, the company's second-largest in the past five years.
  3. A single contract accounted for 88.2 percent of revenues last year, and no new sizeable contracts have been announced for fiscal year 2014. Therefore, revenues likely will fall off a cliff in future years unless another major contract is announced.
  4. KONE chairman Tao Li devotes 70 percent of his time to running another company, China Green Agriculture (NYSE:CGA). In 2011, CGA was investigated by the SEC. KONE became listed on the NASDAQ through Robert McCooey, who brought many large Chinese reverse-merger disasters to the NASDAQ.
  5. When compared to other nano-cap Chinese stocks, KONE is extremely overvalued and should be trading at around $2.93 per share.

Introduction:

KONE stock recently rocketed from $2.82 per share to an absurd $12.30 per share during January. KONE's recent-earnings press release makes the company seem attractive, but its annual report (20-F) paints a different picture. KONE hasn't grown revenues for the past five years, and the company became unprofitable over the past two years. Earnings actually fell short of management expectations, and the large increase in revenues for 2013 was due to a single large contract, with no other large contract announced since. 3D Analytics has completed a thorough review of KONE and determined the stock is grossly overvalued. Consequently, we hereby assign a SELL rating on the stock with a $2.93 price target.

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Financials:

On Jan. 17, 2014, KONE announced fiscal year 2013 earnings, and shares rocketed up around 150 percent on Friday and 336 percent in January. But those 2013 earnings were compared only to those of 2012, when revenues and earnings were extremely poor. In reality, when compared to the past five years, those numbers aren't so great.

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In the fiscal year 2013 earnings release, the company gave the following highlights, which are accompanied here by our commentary:

KONE highlight No. 1

Revenues increased by 696.8 percent, to approximately $11.6 million, up from approximately $1.5 million in 2012.

3D Analytics response

Revenues for 2012 are a poor comparison because they were extremely low compared to those of the five-year period (2009-13) as a whole. In 2013, 88.2 percent of revenues came from a single contract and were right in line with 2009 results, proving the company's revenues haven't grown over the five-year period.

KONE highlight No. 2

Gross profits increased by 527.7 percent to approximately $1 million, up from a loss of approximately $200,000 in 2012.

3D Analytics response

Gross profits for 2013 were the second-worst for any year during the five-year period and were dramatically lower than those from 2009-11.

KONE highlight No. 3

Gross margin increased to 8.8 percent, compared to minus-16.4 percent in 2012.

3D Analytics response

The gross margin for 2013 was the second-worst of any year during the five-year period and was dramatically worse than 2009-2011 results.

KONE highlight No. 4

A net loss of approximately $5.1 million compared to a net loss of approximately $9 million for 2012.

3D Analytics response

Earnings for 2013 were the second-lowest of any year during the five-year period and were dramatically lower than those of 2009-11. If you include all of KONE's off-balance-sheets arrangements, the company had a net loss of $7.572 million for 2013.

KONE highlight No. 5

Basic and diluted loss per share was $3.65, compared to loss per share of $6.40 for 2012, with weighted average shares outstanding of 1.405 million for both years.

3D Analytics response

Net loss per share for 2013 was the second-worst of any year during the five-year period and was dramatically worse than 2009-11 results.

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On May 22, 2013, KONE reported financial results for the first six months of fiscal year 2013. As stated in the release, management expected revenues of $8.7 million to $11 million for the fiscal year ending Sept. 30, 2013, with a net loss $1 million to $1.8 million. Although revenues hit management's expectation, net loss was a huge miss!

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Major Customers:

On Oct. 9, 2012, KONE signed a contract with Huala Engineering and Technology, a deal that was expected to generate $17.2 million in revenue. During fiscal year 2013, that contract contributed approximately $10.2 million, or 88.2 percent of KONE's revenue. With advances from customers having climbed by $7.5 million during fiscal year 2013, it is expected that this contract will contribute another $7 million for fiscal year 2014. KONE has yet to announce any other large contracts. Therefore, unless a major contract is announced, revenues likely will fall off a cliff in future years.

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Tao Li , China Green Agriculture and Robert McCooey:

According to the latest 20-F, KONE chairman Tao Li devotes approximately 70 percent of his professional time to his duties for CGA. In 2011, CGA was investigated by the SEC. We recommend investors read the great Seeking Alpha article written by Roddy Boyd on May 16, 2011, which provides greater detail on Tao Li and CGA and explains how KONE came to be listed on the NASDAQ through Robert McCooey, who brought many large Chinese reverse-merger disasters to the NASDAQ.

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Valuation:

KONE is significantly overvalued when compared to other nano-cap Chinese stocks. When using Finviz to screen for all Chinese nano-cap stocks, we found Finviz listed a total of 45 companies, almost half of which are profitable (KONE isn't profitable). KONE reported $11.562 million in revenues for fiscal year 2013 and currently has a market-cap of $17.2815 million. This gives KONE a current P/S (Price-to-Sales) ratio of 1.49. When comparing KONE's current P/S ratio to those of other nano-cap Chinese stocks, KONE has the second-highest and is significantly higher than the median of .31.

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Since the P/S distribution of 45 nano-cap Chinese companies is not a normal distribution curve, it is best to use a median P/S ratio instead of the mean to determine the stock price for KONE. Using the median P/S ratio of .31 and sales of $11.562 million, KONE should be valued at around $2.55 per share. For the fiscal year ending Sept. 30, 2014, management expects revenues of $12-15 million. If we use $15 million for the sales, KONE should be valued at around $3.31 per share. Therefore, we conclude KONE should be trading at around $2.93, which is the average of $2.55 and $3.31. Ironically, prior to last week, KONE stock was trading at around the $2.93 level.

Conclusion:

We believe this month's increase in KONE share price was unwarranted and that shares likely will fall back to where they began the year. There hasn't been a large contract announced since the Huala Engineering and Technology deal, which accounted for 88.2 percent of KONE's 2013 revenues. If no other large contract is announced soon, future revenues likely will fall off a cliff. We hereby assign a SELL rating on the stock with a $2.93 price target.

Source: Kingtone Is Significantly Overvalued With Shares Likely To Fall By 75 Percent; $2.93 Price Target