Lentuo International Update - Chairman And CEO To Make $1 Million Purchase In Open Market And Other Developments

Summary

• Chairman Mr. Hetong Guo and Chief Executive Officer Mr. Jing Yang will use their personal funds to purchase up to $1 million in LAS Shares on the open market.
• The joint venture with BITA and UXIN was officially certified by the Chinese government and operations are expected to start in the current 1Q 2015.
• The company has laid out its 4-pillar growth plan designed to accelerate revenue, gross margin, and net income growth in 2015 and beyond.

Lentuo International (NYSE: LAS) operates eleven franchise dealerships, ten automobile showrooms, one automobile repair shop and one car leasing company. Its brand lineup includes Audi (AUVDF), BMW (BAMXY), Volkswagen (VLKAY), Toyota (TM), Honda (HMC) and Mazda (OTCPK:MZDAY). Lentuo is the largest non-state-owned automobile retailer in Beijing. Lentuo as a company and its Chairman Hetong Guo in particular have won several awards ranging from quality to entrepreneurship over the years.

Besides new vehicles, the company offers spare parts and accessories as well as automobile repair and maintenance services. More recently the company has targeted China's burgeoning pre-owned car sales market as a major growth engine and it's building the infrastructure needed to support this growth. In recent years, the company has been adding parts, maintenance, insurance, automobile financing, and other high-margin after-market products to its suite of products.

Readers are encouraged to review my latest article on LAS, "Lentuo International's Growth Plan Could Reward Investors," in which I discuss in detail the company's growth plan for months to years ahead. This way I feel that they will be able to better understand this update which I call it "The Good, The Bad, and The Ugly."

The Good

Two of the top concerns that I voiced at the start of my January 6, 2015 article have been answered positively by two recent press releases. The first was my doubt about the validity of the May 27, 2014 announcement that the Chairman and CEO decided to buy up to $1 million LAS shares in the open market - to show their confidence and bullishness about the company's short and long-term prospects. My concern was because the 12-month deadline to consummate this purchase was fast approaching and there had been no updates about its status by Lentuo's management.

This concern was answered on January 22, 2015 through a press release announcing that members of senior management team, including its Chairman Mr. Hetong Guo and Chief Executive Officer Mr. Jing Yang, will use their personal funds to purchase the Company's American Depositary Shares on the open market for an aggregate amount up to a maximum of US$1.0 million as soon as possible within one month.

Mr. Guo commented,

"This share purchase demonstrates our management team's confidence in the long-term prospects of Lentuo's business. We believe we are implementing sound strategies in building our relationship with BMW and other premium brands, cooperating with Bitauto and Youxinpai to expand our online-to-offline platform for high-end pre-owned car business, and enhancing our high-margin after-sales services. We are steadfastly moving our business model towards an emphasis on margins as much as market share. We hope that you, our shareholders, will share our confidence."

This announcement was on the heels of the Chairman's letter published on January 7, 2015 in which he mentioned about the insider purchase but gave no specific deadline - until today.

Mr. Guo concluded his 2014 letter stating the following:

"While our full-year results are still a few months away from release, I can tell you that I am confident we will sustain the momentum of the first three quarters through the end of the year. Last May, when we announced a share purchase plan for senior management, I described it as a sign of confidence in our long-term prospects. I am even more confident today. We made the right choices in moving our business model towards an emphasis on margins as much as market share. We hope that you, our shareholders, will share our confidence, and thank you for your loyalty and the trust you have placed in us."

As a percentage of the current $25 million market cap, the $1 million insider purchase by Lentuo's management would represent one of the largest in the entire market over the last 12 months.

Other highlights of the Chairman's letter focus on identifying the "Four Pillars of Growth" aimed at increasing both margins and revenues and summarized as follows:

First Pillar: Building its Relationship with Premium Brands

1. Higher Margin on premium new car sales vs. non-premium - Higher margin on repair and maintenance of premium vs. non-premium cars.
2. In October 2014, BMW, China's second-grossing foreign brand, granted approval for Lentuo to become an authorized BMW dealer. This will be the company's first BMW dealership, located in Gaobeidian, just south of Beijing in the Beijing-Tianjin-Hebei economic triangle. When in full swing this new dealership will add about $60 million in high margin revenues/year of about 15% of total revenues - compared this to the current market cap of only $20 million!
3. The company is in discussions with a number of other high-end brands to expand its premium-car offerings with an emphasis on dealerships outside Beijing where growth is accelerating.

Second Pillar: Building Brand Visibility Beyond Beijing

1. The new BMW dealership, located in Gaobeidian mentioned above is an actual example of that trend. The largest threat to LAS has been Government Regulation and the Beijing quota to curb pollution in that city. Despite these regulations LAS has increased revenues in 2014 vs. 2013 - and will do so to a greater extent by selling premium cars outside Beijing were growth has been reported to be higher than 30% year over year.

Third Pillar: Certified Pre-Owned Car Business

1. The recently registered JV with Bitauto Holdings Limited (BITA) and UXIN aims to make the JV players first-movers in the Online-to-Offline (O2O) sales and marketing strategy. Consequently, the JV is expected to gain a significant market share in China's fast-growing high-margin luxury pre-owned car business (see the Bloomberg video and refer to my January 6, 2015 article for projected growth rates for the next few years). The official certification of the JV was the second highest concern I voiced in my article. This is because countries like China are notorious for having many layers of red tape and bureaucracy that could slow down business plans significantly. My latest LAS article discusses in detail the JV's operating philosophy and strategy and the potential effect on Lentuo's top and bottom line as the JV's activities and reach ramp up.
2. In 2014, Lentuo joined the China Automobile Dealers Association's ("CADA") newly-launched Xing Certified Pre-Owned Car Alliance ("Xing Alliance"). The Xing Alliance will oversee the nationwide rollout of CADA's pre-owned car technical inspection and analysis procedures.

Fourth pillar: High-margin after-sales services

1. This is a reflection of the company's focus on premium cars. In the first nine months of 2014, Lentuo serviced 144,850 vehicles, essentially the same number as in the same period of 2013. Revenues, however, increased by 17 percent to RMB 336.2 million ($54.8 million) from RMB 287.3 million ($47.7 million) in 2013, with the average unit price for repair and maintenance services increasing by 18.1 percent, to RMB 2,321 ($378). In addition to maintenance and repairs the company is now offering parts, insurance, auto financing, and other high-margin after-market services.

Another factor that falls into the "Good" category is the assertion by Chairman Guo that the positive earnings trend established in 2014 will continue through the end of the year. 4Q 2014 will be announced in March 2015. In his 2014 letter he stated: "While our full-year results are still a few months away from release, I can tell you that I am confident we will sustain the momentum of the first three quarters through the end of the year."

Net income for the first 3 quarters of 2014 increased by 31.8 percent compared to the first nine months of 2013, to RMB 40.8 million ($6.6 million) on revenues of RMB 2.4 billion ($323 million), a 0.5 percent increase compared to the first nine months of 2013. The higher net income was primarily due to a 17% increase in repair and maintenance service revenues year over year. Gross margins in this segment increased to 42.2% in 2014 compared to 38.9% in 2013 due to the company's successful execution of its plan to increase margins and revenues of after-sales products and services.

Net income per share increased in every quarter of 2014 as follows:

1. 1Q 2014: 2.2c/share
2. 2Q 2014: 6.8c/share
3. 3Q 2014: 9.1c/share

1Q 2015 will be announced in May 2015, long before the conclusion of NYSE's 6-month grace period to regain compliance with the minimum $1/share average closing price requirement . The company announced the NYSE non-compliance letter on January 20, 2015. I expect 1Q 2015 to be strong following the trend established the prior 4 quarters and high-margin revenue contributions from the JV which will start operations during the quarter.

The Bad

I have mentioned about the January 20, 2015 NYSE non-compliance letter above. The company has 6 months to cure that deficiency. With the positive catalysts that I see ahead as will be seen later, I am confident that the company will regain compliance before the deadline

The Ugly

The obvious one here is LAS' chart. Right after the NYSE letter, the stock price hit an all-time 62c/share price. The company has been in this situation several times in the past as can be seen in the 5-year chart but it has quickly bounced to the $5+/share territory. With the significant growth prospects related to successful execution of the 4-pillar management plan, LAS is stronger now than ever before.

On the surface current valuations are ugly (and in my opinion unwarranted), but value investors will probably see LAS as a unique investment opportunity:

Consider these valuations as of January 21, 2015 when I started to write this article:

1. Trailing PE 3.6;
2. Price to sales Ratio of 0.04;
3. Price to Book Ratio 0.13;
4. Book Value of $5.12;
5. Enterprise Value to EBITDA of 4.18;
6. Cash per share $0.96 - Higher than the current market cap

The market is obviously ignoring the company's growth potential and the progress is has made in growing net income in 4 consecutive quarters. But I expect a major correction in weeks ahead

Near-Term Catalysts

The following are positive events that I see for the weeks and months ahead:

1. Official announcement of the completion of the insider purchase discussed on the company's January 22, 2015 press release. This is a large purchase which will require management to use non-blackout windows of time to be executed.
2. Official announcement of the completion of the new luxury pre-owned car dealership expected by the end of January 2014 as stated in 3Q 2014 earnings release. This dealership is another key step in getting the JV in operational mode.
3. Official announcements of new luxury car representations as stated in the 3Q 2014 earnings release. I expect the new luxury brands to expand outside Beijing per the current trend and management's expansion strategy.
4. Positive 4Q 2014 earnings results and a culmination of a great year. This announcement will be made in March 2015.
5. Positive 1Q 2015 earnings results reflecting increasing revenues and net income as JV operations start to ramp up. 1Q 2015 will be announced in May 2015.
6. Announcement that the company has regained compliance with NYSE's requirements.
7. I have suggested that the company consider instituting a share buyback program now that the stock price is ridiculously low. Obviously this will be a management's decision and I cannot assure a positive outcome.

Conclusion

It is widely accepted fact that pre-owned car sales in China will grow exponentially going forward, far outpacing new car sales. The now officially registered JV between Lentuo, Bitauto, and "UXIN" and the completion of the new luxury pre-owned car dealership in Beijing this month will enable the JV to start operations during the quarter.

As a percentage of the current $25 million market cap, the $1 million insider purchase by Lentuo's management would represent one of the largest in the entire market over the last 12 months. That to me is in line with what my readers ask me frequently regarding small-cap Chinese companies - that they would invest in such a company only if management "puts its money where its mouths is." Contrary to many Chinese small cap companies, LAS was not created through a shady reverse-merger arrangement. Lentuo had its IPO executed at $8 in December 2010 and underwritten by reputable Cowen & Co. and HSBC.

I fully expect that Lentuo will successfully execute its 4-pillar growth plan as shown by the progress made in 2014 based on goals established in 2013. Lentuo's current valuation of 0.04 times sales and 3.6 PE clearly does not reflect its significant upside potential However, I expect it to go up significantly as the benefits of the company's long-term strategy begin to show positive results throughout 2015 and beyond. My expectation is that LAS will be trading well North of $10 and possibly into the $20's in 2016.

Investors considering investing in LAS should examine all the risks and uncertainties as spelled out in the company's filings with the SEC. In addition to the risks listed in the filings and at the start of this article, other risks that need to be considered are 1) unsuccessful JV efforts to gain market share, 2) not regaining NYSE compliance before the 6-month deadline, 3) overcoming the perception of being a microcap Chinese company trading in the US markets despite a major insider purchase and good execution of the company's growth plan.

Editor's Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.

Analyst’s Disclosure: The author is long LAS. 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.