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Everyone's running scared from Chinese stocks, and with good reason. There have been a ton of scandals, the corporate structures are often too complex to understand, and it's hard to really know whats going across the Pacific Ocean, particularly when the stock went public in a reverse merger.

But that is of course the best time to start finding the gems that are accidentally being thrown away with the rocks.

Giant Interactive (NYSE:GA) is one of those gems that can easily double from here over the next year. It's not a hard story to explain. The company is in the online gaming business, which is booming in China. But it's got several things going for it that give it significant margin of safety:

  • $860mm in cash with $0 debt. Not bad for a company with market cap of $1.5bb. In other words, more than half the company is in cash.
  • The stock trades for 5x next year's earnings if you back out the cash. The S&P 500 trades for about 14x next year's earnings. So that right there could imply a triple. By comparison, other online China stocks, such as BIDU and SOHU, trade at 84 times earnings and 20 times earnings respectively.
  • GA owns 25% of 51.com. Here's an article on 51.com that suggests it could be the "Facebook of China". 51.com has 160mm users. Facebook itself is worth about $50bb. 51.com is worth significantly less but at the very least the GA stake could be worth several hundred million, which would value the core GA business at about $0. Intel (NASDAQ:INTC) and Sequoia are also investors in 51.com.
  • Goldman Sachs just came out with a report that put a $9 price target on the company. The stock has been flat since the report.
  • The company is not a reverse merger (in fact, Goldman Sachs did the IPO).
  • GA has a 2.5% dividend. Other online gaming companies (SNDA, PWRD, NTES) give 0% in dividends.
  • The company is being valued by the stock market as if their gaming business is worth less than zero. But their gaming business actually is booming. They generated $122mm in EBITDA over the past 12 months. Revenue grew 17% year over year last quarter. They just launched a new game, ZT2, and the test results are going very well with 280k peak concurrent users over the past seven days.
  • They have some good shareholders: Renaissance Technologies, one of the best hedge funds ever, owns over 1mm shares.
  • They are doing a $110mm share buyback, buying back almost 9% of the company, which will further increase its earnings per share.

Because of the cash, the share buyback, the dividend, and the stake in 51.com I think there is very little downside and a good margin of safety. Because of its extremely low multiple of earnings, and its growing gaming business, I think there is very good upside. Goldman put out a $9 target and I wouldn't be surprised to see it exceed that over the next year.

Source: Giant Interactive: The Cheapest Stock in China