PacificNet: This 'Unusual Chinese Play' Warrants a Closer Look

It began early last year. In late January 2006, an article appeared in Business Week column “Inside Wall Street” recommending PacificNet (PACT). “An unusual Chinese play” is how Business Week labeled PACT.

Since then PACT has been a mild roller coaster ride. On February 1, 2006 PACT hit an intraday high of $8.10. From that day PACT has retraced its gains and closed at $5.27 on April 2, 2007.

PACT warrants a closer look.

The Company

PACT is a provider of value added telecom services, outsourcing services, and communication products. PACT’s business process outsourcing services include call centers, customer relationship management and telemarketing services. Information technology outsourcing includes software programming and development. Communication products segment includes calling cards, GSM/CDMA products, and multimedia self-service kiosks.

In the past month PACT, through its Hong Kong based subsidiary Take 1, has successfully launched and sold electronic gaming machines by leading gaming operators in Macau (Jai Alai Casino), Asia and Europe. The addition of new product lines such as electronic gaming machines, electronic multi-player table games, slot machines, VLT and bingo machines allows PACT to target the rapidly growing gaming market, gaming operators and gaming industry. The company is well positioned to benefit from current Asian and global gaming expansion.

Financial Metrics

In the January 2006 Business Week article, Tian Hou of C.E.Unterberg Towbin, forecast PACT to report profits of 26 cents on revenues of $50 million. For the first three quarters of FY 2006, PACT reported total revenues of US$ 47.22 million. However, EPS was affected following a reported loss of $ - 0.10 posted in Q3, 2006.

For the first three quarters of 2006 revenues were US$ 47.22 million up 54.43% versus the first three quarters of 2005 in which revenues totaled US$ 30.60 million.

Gross Margins for the trailing twelve months were at 31.10% versus a sector average of 42.80%

EPS was down in Q3, 2006. PACT reported a loss of $ -0.10 per share versus an EPS of $ 0.06 for Q3, 2005. The loss posted in Q3, 2006 resulted due to changes in China government policies that affected the value-added telecommunications sector within China.

PACT has since adjusted its business model and moved away from the heavily regulated and low margin telecom sector within China. Recent entry into Asian and global gaming market allows PACT to substitute a low margin and heavily regulated sector with a high margin one, namely Gaming.

Segment Analysis

Value Added Services – Telecom have historically been an important component of earnings. PACT’s ability to improve margins in its Gaming business remains vital to the successful transformation of its business model.

Sentiment Analysis

A total of 1.01 million shares (12% of Float) were short as of March 11, 2007, which would take 3 days to cover. PACT has one – Neutral; one – Under perform; and one – Sell recommendation. I would not expect short covering to catalyze stock price appreciation should the Company announce strong annual results on April 10, 2007.

Pessimism from the analysts is strong. PACT is well positioned for upgrades in analyst ratings once its business model begins to hum.

Front month contracts for April show a large number of “in-the-money” Calls priced in at $5.00. In the front month of May, there is a build up of a large number of “out-of-the-money” Puts at US$ 5.00. I expect strong support for PACT at $5.00 based on the way the option players are hedged. PACT also has support at its 20-day moving average. This provides protection from any downward movement in the stock price.

I expect the next level of resistance to surface at $7.50, where there is substantial build up of “out-of-the-money” Calls for the front month of June.

The stock has been under accumulation since March 15, when it was at an intra-day low of US$ 4.85. The near term direction for PACT points higher. I expect the stock to rally once the current stage of consolidation is completed.

Disclosure: Author is long PACT

PACT 1-yr chart