NQ Mobile (NYSE:NQ) today announced a minority sale of its wholly owned subsidiary Beijing NationSky Network Technology Inc. to Beijing Guorun Qilian Venture Capital Center for a post-money valuation of $530 million. The deal also calls for an IPO or sale of the subsidiary within the next two years at a price that is nearly double the company's current market value. Even without the deal, shares are trading at a significant discount given growth in sales. The release of the special audit report clears some uncertainty over the company and the risk-reward tradeoff is firmly positive.
The deal that doubles NQ valuation
NQ Mobile fully incorporated NationSky last year with the purchase of the 45% it did not own in the subsidiary. The remaining stake was bought for $25.2 million in cash and Class A common shares which puts the total valuation around $56 million. The subsidiary is an enterprise mobile service provider, founded in 2005 through a partnership with China Mobile (NYSE:CHL) and BlackBerry (NASDAQ:BBRY).
Growth in enterprise mobile, especially in China, has taken off over the last year and NationSky has announced some significant agreements. In January, the company announced that it would deploy its NQSky MDM platform on more than 500,000 devices for the National Bureau of Statistics of China. NationSky became a tier one distributor for Apple (NASDAQ:AAPL) in the first quarter 2013. The company provides mobile information management for more than 80 Fortune 500 companies and more than 1,250 large enterprise customers around the world.
This morning's announcement values the subsidiary at $530 million with 3.4% sold to the venture capital group and another 2.3% that NQ Mobile intends to sell to other investors over the next two months. The most important part of the deal for NQ investors is the stipulation that, "The investors have a right to demand the redemption of their shares if NationSky does not complete a qualified initial public offering, or find a third party buyer to acquire all or part of its shares for a valuation of at least $550 million for NationSky's business within 24 months after the investment is completed."
NQ Mobile reported total net revenue from NationSky of $23.4 million in the fourth quarter of last year, for an increase of 52% over the prior quarter, and a net income of $2.98 million from the segment. NationSky's gross margin in the fourth quarter was approximately 21%, slightly lower than the previous quarter on increased hardware device procurement costs. The subsidiary's GAAP operating margin was 12.1% over the quarter.
NQ Mobile had a market capitalization of $577 million at Monday's close of trading. Admittedly, this is artificially low due to the ongoing allegations of fraud by Muddy Waters but this one deal says that NQ Mobile is going to seek to nearly double that valuation over the next two years on NationSky alone. Today's announcement follows an earlier deal announced June 1st that the company had agreed to sell a 5.88% stake in FL Mobile to Bison Mobile Limited and other investors. It is clear that the company is looking to monetize its subsidiaries and bring in as many investors as possible.
How Much is NQ Mobile Worth?
While today's announcement improves the outlook for the shares, it is hard to quantify how much it adds to the current valuation. Shares have fallen since the open but holding on around the unchanged-mark, a welcome change for investors accustom to seeing the share price fluctuate wildly almost daily.
Even without the potential from the NationSky deal, which could take up to 24 months to materialize, the shares are considerably undervalued. The shares currently trade for an enterprise value of just 1.4 times 2014 expected sales of $330 million and a price multiple of 7.5 times expected earnings of $1.25 per share. This is exceptionally low for a company recording high double-digit increases in annual sales, expected 66% higher this year. I am applying an enterprise multiple of 3.0 times sales, which is still conservative for that kind of growth, for a target of $16.12 per share on this year's sales and a target of $20.77 per share on next year's sales. This is still under the share price high of $24.92 reached before the fraud allegations but a significant profit from current levels. These targets are likely overly conservative, especially given the growth the company has booked over the last two quarters and the deal announcement for NationSky.
Of course, this is assuming you believe that the company will continue to operate and dismiss the allegations brought on by Muddy Waters.
I have been an investor since Muddy Waters released its initial report in October and have bought more shares recently after the company missed its filing deadline for first quarter results. I have read the Muddy Waters report, the press releases by the company and the release of the third-party investigation. While some of the accusations by Muddy Waters raised red flags, especially the days sales outstanding, but none merited the idea that the company was a fraud. I believe the auditors wanted to wait to review the results of the special investigation and that the first quarter filing will be released shortly.
NQ Mobile lost nearly $500 million in market value when Muddy Waters released its report in October. With a current valuation around $577 million, a potential IPO of NationSky worth $550 and the return of at least some of the pre-Muddy Waters valuation the shares could offer a significant return for those risk-tolerant investors willing to stick around. My own current valuation is for $16.12 per share this year once the company is able to prove itself and move one from the fraud allegations.
Disclosure: The author is long NQ, AAPL, BBRY. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.