IPO Preview: Xunlei Ltd.

Jul.18.11 | About: Xunlei Limited (XNET)

Based in Shenzhen, China, Xunlei Limited (proposed symbol: XNET) scheduled a $114 million IPO with a market capitalization of $315 at the price range mid-point of $15 for Wednesday, July 20, 2011. The full IPO calendar for the week of July 18th includes seven IPOs.

BIG PLUS - Sohu.com (SOHU, $3 billion market cap) has committed to buying $10 million in a concurrent private placement that they will hold for at least 180 days.

BIG MINUS - XNET has a 'material weakness' in its accounting systems it expects to rectify by the end of 2012 - by the end of 2012?

DECLINING INCOME STATEMENT RATIOS - Even though top line revenue is increasing on a sequential quarterly basis, gross profit in the last six quarters has dropped from 78% to 61%, operating income has dropped from 18% to 15%, and net income has dropped form 20% to 13%.

In the last three quarters net income declined from the September quarter ($2.7 million) to the December quarter ($2 million) to March the quarter ($1.9 million).

CONCLUSION - At the price range mid-point of $15, XNET would sell for 41 times annualized March 2011 quarter earnings and 5.6 times sales. At the IPO price of $15 XNET may be a risky speculation in the short term.

XNET Valuation Metrics

Each ADS represents three Class A common shares.

BUSINESS - The core download acceleration functionality makes Xunlei Downloader the most popular download acceleration application in China, with a 78.7% market share based on the number of software launches among all download software in China in February 2011, according to iResearch.

Xunlei Downloader was used in an average of approximately 138 million downloads per day in 2010. These downloads are available to internet users free of charge. To complement XNET's download services and to further broaden users access to video content via online streaming, XNET also launched an online video streaming services in 2007 on the Xunlei Kankan website.

Xunlei Kankan is the third largest video streaming portal in China, as measured by the monthly unique visitors from homes and offices in April 2011 according to iResearch. Xunlei Kankan had 120.7 million monthly unique visitors from homes and offices in April 2011.

UNIQUE USERS - XNET's target range of monthly unique visitors that XNET currently tries to maintain is from 110 million to 140 million. According to iResearch. Xunlei Kankan had 120.7 million monthly unique visitors from homes and offices in April 2011.

REVENUE SOURCES - XNET generates revenues from multiple sources, including cloud-based subscription services, online advertising, and other services. Multiple revenue streams provide with both revenue diversification and multiple growth areas.

XNET implemented its current cloud-based subscription service revenue model in March 2009 and, by the end of March 2011 had developed over 1.3 million subscribers from the large user base of Xunlei Downloader and Xunlei Kankan.

XNET also generates online advertising revenues derived principally from various forms of advertisements that XNET places on Xunlei Kankan and Xunlei Downloader.

RECENT DEVELOPMENTS - The continued strong growth of subscription-based business in the first quarter of 2011, as evidenced by a rapid increase of the subscribers of XNET's premium download-related services from 898,494 as of November 30, 2010 to 1,290,000 as of March 21, 2011;

The launch of an iPad-version of Xunlei Kankan, a key strategic initiative which enjoyed immediate market acceptance upon release, is expected to bring new business opportunities to XNET.;

XNET entered into a series of exclusive content licensing agreements with content owners and secured the exclusive rights of two blockbuster movies in the first quarter of 2011.

XNET entered into framework agreements with some major brand advertisers that further support the value of Xunlei Kankan as a leading online streaming platform.

S-1, page 95

MATERIAL ACCOUNTING WEAKNESS - Since March, at least five Chinese companies have been delisted and 15 suspended on the Nasdaq, and share prices have been hammered. Of the 52 mainland companies listed on the Nasdaq since 2010, only 8 have share-price gains this year, according to a recent Nomura report.

On page 87 in the S-1 XNET says:

We expect to complete the measures discussed above by the end of 2012 and will continue to implement measures to remedy our internal control deficiencies in order to meet the deadline imposed by Section 404 of the Sarbanes-Oxley Act.

COMPETITION - XNET faces significant competition in different areas of its business.

XNET's Xunlei Kankan website competes with other major online video companies such as Youku.com (NYSE:YOKU) and Tudou.com. XNET's Xunlei Downloader primarily competes with e-Mule, FlashGet and Tencent with QQ Cyclone (OTCPK:TCEHY).

EMPLOYEES - XNET had 810 employees as of December 31, 2010

CONCURRENT PRIVATE PLACEMENT WITH SOHU - Concurrently with, and subject to, the completion of this offering, Sohu.com Limited, a non-U.S. entity affiliated with Sohu.com, a leading internet portal in China, has agreed to purchase from XNET $10 million in Class A common shares at a price per share equal to the initial public offering price adjusted to reflect the ADS-to-common share ratio.

SOHU has agreed with the underwriters not to, directly or indirectly, sell, transfer or dispose of any Class A common shares acquired in the private placement for a period of 180 days after the date of the final S-1 fililng, subject to certain exceptions

USE OF PROCEEDS - 925,000 ADSs to be sold by shareholders. 6.75 million ADSs to be sold by XNET to net $89 million, allocated to

  • $20.0 million to establish a customer service center and cloud computing data centers to better serve our subscribers;
  • $20.0 million to acquire digital media content and exclusive online game licenses;
  • $10.0 million to invest in technology, infrastructure and product development efforts; and
  • the balance for other general corporate purposes, including working capital needs and potential acquisitions (although XNET is not currently negotiating any such acquisitions).

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.