Yesterday, Citron Research tweeted:
$MOBI Former Citron story now in turnaround mode. Transition to smart phones could create big opp. if China Internet stays strong. LONG
As I will explain in this article, I agree with Citron's change of heart on Sky-mobi (NASDAQ:MOBI). Because of its easy to predict growth, its gargantuan market, and low valuation compared to other Chinese mobile companies, I put its current valuation at $25 per share. I show in the last paragraph the numbers on how I came to this valuation.
Baidu (NASDAQ:BIDU), Qihoo (NYSE:QIHU), and Sky-mobi provide some of the biggest smartphone application platforms in China. The way the top wireless carriers, China Mobile, China Telecom, and China Unicom, work is they all have many different stores in each city in China. Each one is managed by a branch manager who, within a set of rules, can run them the way he sees fit. It's like a franchise. They have the leeway to install whichever app platform they want on the customer's Android phone. It isn't like in the US where cell phone companies make decisions on a national level and all Android phones have Google's app platform on them.
When it comes to the low-cost smartphone app economy in China, more cell phone stores are choosing MOBI's app platform over QIHU and BIDU.
Before I get into the numbers, you might be wondering how can a small mobile platform technology company like MOBI be beating out internet and mobile behemoths BIDU and QIHU? I have found five reasons why this is happening.
1. Unlike BIDU and QIHU, MOBI has an on the ground sales force. BIDU and QIHU are tech companies, and don't have dedicated sales forces calling on brick and mortar stores. It's similar to Google (NASDAQ:GOOG) here in the US, Google doesn't go out knocking on doors. MOBI's active salesforce allows it to establish and maintain relationships with cell phone stores.
Wireless carrier behemoths like China Mobile (NYSE:CHL) allow cell phone stores all over China to use the China Mobile name, and they have the flexibility to engage the customers as they wish as long as they fulfill certain quotas. Therefore, a Sky-mobi salesman can contact a particular cell phone store and win business to pre-install the Sky-mobi app platform, Maopao, and other apps on new smartphones sold to customers. This personal relationship wins over many stores to Sky-mobi. Also, Sky-mobi has always been a dominate feature phone app provider in China, and it has maintained many of its relationships as it has transitioned to smartphone apps.
2. MOBI specializes in tier 2 and tier 3 cities and cheaper smartphones. MOBI targets less sophisticated, lower class Chinese who might be getting their first smartphone. Whereas BIDU and QIHU customers are usually more sophisticated and upper class smartphone buyers. This allows MOBI to spread its influence among all the small towns and villages in China. MOBI goes where BIDU and QIHU don't have the inclination to go. Tier 2 and 3 customers is a vast, practically unlimited market in China. China is like the wild wild west. There are all kinds of small cities and villages spread out across the country with privately owned cell phone stores. Many of the people in those small cities are new buyers when it comes to smart phones. Because the majority of Chinese people make low incomes compared to the US, most of them can't afford higher end smartphones like the Samsung Galaxy S4. We're currently in a period of rapid migration from feature phones to smartphones in China. MOBI will get the majority of fledgling smartphone users to use its app platform.
3. Sky-mobi encourages customers to use more data. Selling data is a primary revenue stream for wireless carriers like China Mobile. So they like the fact that Sky-mobi knows how to pre-install apps that are engaging and enjoyable to customers and require the use of more data. The smartphones in China are usually under a "pay as you go" plan, so when customers use more data, they have to pay extra for it. Qihu and Baidu provide more sophisticated apps and platforms, but aren't as focused on encouraging customers to higher levels of data use.
4. Big cell phone carriers like China Mobile, China Unicom, and China Telecom, don't necessarily want to give more business to big technology companies like BIDU and QIHU. BIDU and QIHU already dominate most areas of internet and mobile, so they don't need them to become even more powerful. They would rather support the little guy, like MOBI.
5. MOBI's applications are better designed for low end Android smartphones. MOBI knows how to create enjoyable, quality apps that work well for a low processing power smartphone. In the F2Q13 earnings call, MOBI's CEO, Michael Song, said:
Another key employment [ph] to strengthening our positioning in Smartphone business is our ability to provide enjoyable and entertaining content to our user. From the understanding of these systems in conception happens between the low cost Smartphone user and average high-end Smartphone user allow us to drive increased user stickiness and in turn deliver sustainable physical and operation growth. As an example we know that this quarter growth of mainstream China user migrating from feature phone are typically in playing simple and easy to games.
But most critical, important aspect is there newly brought Smartphones normally and cannot power [ph] many of these games made for high end Smartphone due to low processing power.
How Sky-mobi And The Cell Phone Company Do Business Together
Sky-mobi has mobile content distribution agreements with many mobile distributors. It pre-loads its mobile content and platform onto a smartphone when the consumer buys it in the store. Then the consumer can download more apps off the Sky-mobi platform, Maopao, at his or her leisure. Sky-mobi and the mobile phone company share the app revenues. The content developers pay Sky-mobi RMB 0.6-1.0 per installation.
Sky-mobi has a sales rep that has a relationship with the individual cell phone store. That Sky-mobi rep advises the cell phone associate what kind of apps to pre-install on the phone to sell to the customer. Sky-mobi will have about 5-10 app packages each with about 10 apps that the associate can install on the customer's new phone. For example, say it's a teenage girl who is getting a new smartphone, possibly her first. Then the sales rep would recommend the "teenage girl" package. Being a teenage girl, most likely she likes karaoke, music, and celebrity gossip articles. So this package would pre-install apps for karaoke, music videos, and a celebrity news source. If the customer is a man in his 50s, it would be a different pre-installed app package that appeals more to his demographic.
Rapid Revenue Growth
For the December quarter revenues, Sky-mobi beat guidance and turned profitable. Its smartphone platform was 56.4% of total revenue, which was the first time smartphone revenue exceeded feature phone revenue. This is a significant shift in the fundamentals of the company.
Sky-mobi used to be one of the largest mobile app store players in the feature phone market in China. With smartphones quickly replacing feature phones, Sky-mobi's core business was hit hard, but it was able to effectively make the shift to smartphone apps in late 2012. 2014 will likely be the last year of declining revenues as MOBI's smartphone platform growth will trump its decline in feature phone app sales.
The following is the estimated future MOBI income statements from research firm Wedge Partners. I think it's an accurate estimate.
Keep in mind the above table numbers are in RMB, not USD. To translate to dollars, expected revenues in fiscal years 2014, 2015, and 2016 are about $78.3M, $121.4M, and $182.1M, respectively. The following are comparables from Thomas Hor's recent article on MOBI.
MOBI is very undervalued at 2x-3x EV/Sales. Especially due to the fact it's a small cap stock and has more growth potential than its large cap peers. Giving it a 10x EV/sales valuation, we calculate an enterprise value of $1.21 billion in 2015, and $1.82 billion in 2016. Backing out $90 million in expected cash balance in those years, that would put its market cap at $1.12 billion in 2015, and $1.73 billion in 2016. This would put its share price at $37 in 2015 and $57.60 in 2016. Discounting back to today from 2016 at an 8% discount rate, MOBI would have a share value of $49 per share. To have a margin of safety, if we halve that share value, we come up with today's value of $25 per share. At around $10 per share today, MOBI's share price could easily rise over 100% this year.
Disclosure: I am long MOBI. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.