Seeking Alpha
Profile| Send Message|
( followers)  

I’ve covered China Media Express (OTCPK:CCME) in a couple of articles, including my top four most undervalued Chinese stocks. After a short attack last week, I wanted some more clarity before reiterating that buy recommendation, and Global Hunter has provided that by going on the ground and performing the due diligence I am unable to do from an armchair (despite the amazing research capabilities of Google translate). Unlike many of the short attacks over the last three weeks, this was an actual visit to China that yielded information you can’t find online. Let’s take a look at the recent Global Hunter report.

Advertisers

One of the things that shorts targeted were the relationships that CCME had with advertisers, or to be more precise, the apparent lack thereof. In their report, Global Hunter approaches this subject directly. GH says they:

Called or met 16 top advertisers, who verified a total of approximately $105MM of revenue or ~50% of our estimated 2010 revenue. We believe the company currently has a total of 40 agencies and 20+ direct advertisers.

This would seem to match up with their revenue numbers, and certainly puts into question Muddy Waters’ reports of only 17% of their revenue being legitimate. Additionally, GH speaks to the competitive advantage CCME has leveraged in terms of bus advertisement, saying:

The advertisers cited the large size of CCME’s bus network, the enclosed environment and captive audience thus a high “reach” rate, and availability of third party (CTR) media monitor as the reasons why they are engaged with CCME.

So, it seems as though there are legitimate reasons for longs to be put more at ease. As I’ve mentioned before, this is the exact environment that my contacts on the ground in China have spoken about. The advertisements are captivating and funny, and the audience is engaged. This is not simply a television advertisement, where people can go into the kitchen for another drink; these are long bus trips where distractions are nonexistent and the viewer is bored. This reach rate is valuable to advertisers trying to get traction in the huge Chinese market.

The next point of attack for shorts involved calling companies like Coca Cola (NYSE:KO), Apple (NASDAQ:AAPL), Sony (NYSE:SNE), Nike (NYSE:NKE) and more to ask them whether they had a relationship with CCME. Now, on the surface you may deduce that not having heard of CCME would mean they didn’t have a relationship with them. On the contrary, advertisements can be placed through extensive channels using China based middlemen. China Telecom (NYSE:CHA), for example is the exclusive advertising agent for Coca Cola and L’Oreal (OTCPK:LRLCY). GH says they:

Called China Telecom, and the exclusive advertising agents for Coca Cola and L’Oreal, who confirmed they have placed ads on CCME’s platform.

Well, that seems to take away some of the sting of the accusations that CCME has no relationships with major brands in the US. Another example is Eading Group, who is an authorized Apple reseller. Hunter says that:

Shanghai Ba-shi Public Transportation and Eading Group also confirmed their partnerships with CCME… We called Eading Group, an authorized Apple reseller, who confirmed they have been selling Apple products through CCME’s Switow platform. Besides receiving a small revenue share, CCME intends to convert Switow’s consumer brands into advertising customers in CCME’s platform.

So, although CCME may not have a direct relationship with Apple itself, they do have a relationship with Apple’s products and the process of marketing them to China’s citizens. This is the most important question to ask: are major brands appearing in CCME’s advertisements? From this report, the answer seems to be a resounding “yes.”

Number of Buses

Another claim that was made by the various shorts referred to the buses that CCME used to advertise. Attacks included saying they were not running and saying they were only charter buses for special events. However, the main attack was on the number of buses that CCME actually placed advertisements on. Global Hunter addressed this issue by speaking directly with the bus operators. GH spoke:

To 17 bus operators, who confirmed that they have signed in aggregate 14,191 buses with CCME, or 52% of the total number of buses CCME reported. We believe CCME currently has 65-68 bus operators. We visited Shanghai Ba-shi Public Transportation (Group) Co., which confirmed they have 1,892 buses engaged with CCME.

So, if they have the buses then it is reasonable to assume they have the advertisements to place on them. This is another blow to the foundation and thesis of the short attack. Another point of conflict was whether there were exclusive rights and contracts to these buses. Global Hunter researched this and decided that their contracts were long term and reasonably represented by management. They said:

The numbers these bus operators reported to us matched the contracts we reviewed at CCME. These bus operators confirmed their contracts were 5-8 years in length and cited the large and established network (no competitors with similar scale), good credibility (make payments on time), and quality services (repair equipment on time and change programs twice a month) as reasons for the engagements.

If the buses exist, then the ads exist, and the revenues from those advertisements would follow. So, if there are buses and advertisements with major brands on them, what is left to poke holes in?

Lack of Publicity

A lack of publicity is something that has been harped on repeatedly by shorts. If they are not known in the major advertising circles of China, how are they managing to pull in these numbers? Longs are careful to remind those shorts that the media structure in China is very much focused on urban areas, which CCME had yet to penetrate until 2010. So, obviously, they would fail to register on many of the lists that were made based on 2009 or early 2010 numbers. Their profile and strategic framework has been focused on smaller, tier II and III cities. Global Hunter explains that:

CCME until 2010 had been focused on expanding its intercity bus network in tier II and III cities, and has utilized regional advertising agencies which have extensive local relationships, rather than many of the national 4A agencies. We believe this niche market position and unique approach has made them less visible but kept them very profitable.

CCME has built strong relationships with advertisers in an underserved market using a phenomenal product. This is the recipe that could breed success in any business environment, but especially in one like China where growth is so explosive.

Filings and Audits

Again, this is one of the places where shorts attack CCME. Although they are using Shanghai Deloitte to audit their books and provide accounting controls, there are still skeptics that insist this is the reincarnation of Rino. However, management has made some moves to be more helpful to auditors and provide more transparency to investors. Global Hunter:

Felt management was eager to prove the legitimacy and validity of its business. The company has been open and cooperative with our due diligence work. We believe the company is currently assisting Deloitte in completing its annual audit, and has been actively collecting third-party verifications.

The annual audit should be valuable once it is released. Furthermore, their third party verifications will do wonders to support their claims of revenue and exclusivity in the advertising realm. However, they need to make sure their filings and statements are in good order as well. Global Hunter looked at these filings while in China, and said:

The company presented to us all of its bus operator and advertiser contracts, tax filings and bank statements for the last three years. The taxes paid and cash balances appeared reasonable and matched GAAP reported numbers.

What more do you need from a small, high growth company in the Chinese market? There are plenty of investments that have yet to provide this sort of visibility to their inner workings, and yet they receive none of the violent short pressure that CCME has been under this year. I believe most of the short interest is in the term of retail followers as opposed to the normal sharks who have already exited their positions. When the stock shoots up, as it is already doing today, these short side rookies will lose their shirts.

Reiterate Buy Recommendation

I am reiterating my buy recommendation on this company due to the due diligence done by GH. I’m not saying that they are the source of all truth in this situation, but coupled with the Deloitte audit and the relative vagueness of the short attack (it seemed like a lot of internet searching and very little groundwork), I feel confident in the recommendation.

At this point in the drama, I have seen enough from both sides to make a reasonable assumption that CCME is a viable company, pounded down by shorts, with upside potential. I am still waiting on an announcement from the management and a little more effort to be honest and forthcoming about contracts and relationships, but for now I am convinced the upside is worth the risk. I am assigning a price floor of $30 and a ceiling of $45, with a generous side of uncertainty.

If you can stomach the assumption that Global Hunter is not churning out fraudulent research at this point, you should be able to admit that this company exists. If you still think there is a conspiracy against you, then you probably should avoid investing in China altogether. The risks are definitely there, but as I’ve said before, they exist in US stocks as well. If you want to make the safe play, choose another investment. For the right person, CCME is a great pick.

Source: China MediaExpress: Reiterating My Buy Based on Global Hunter Report