Investor Assesses China Techfaith Wireless' Weak Stock Performance (CNTF) 20 comments
September 23, 2005
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Mobile handset designer China Techfaith Wireless (ticker: CNTF) has seen its stock price drop over 30% since the beginning of September. What explains the weak stock performance? The following is a comment left on The China Stock Blog earlier today:
CNTF is definitely a “star
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This article has 20 comments:
tinyurl.com/7l44a
They still expect strong y/y growth in FY06 of roughly 30%. Stock is trading at 8x FY06 estimates. Looks cheap to me, esp. with $3.00/share in cash on the balance sheet.
Why did they cut estimates?? Who knows. The company did say that they had fewer design wins during Q2 than in Q1, so perhaps that is fueling some fear that revenues and eps will not be as strong in coming quarters.
Other concerns? There will be a lot of shares coming off lock-up in November, but there have been no Form 144 filings showing intent to sell.
Looks really oversold to me, but without news regarding business and current trends, the stock will sink in this vacuum. Very frustrating.
In fact, the only news I could find is an article from Reuters. It can be found in many sites including CNTF's IR page, but not on Yahoo! Finance. Take a look. It seems CNTF is a favorite partner for the Japanese and Kyocera has promised big orders to CNTF.
Japan looks offshore for cell phone R&D
TOKYO (Reuters) - Japanese cell phone makers are venturing out of their home-based product development shops and testing the vibe at outsourcing firms in China and India, heeding a wake-up call from their more aggressive global rivals.
The move by Japanese companies is still at an early stage, with industry heavyweight NEC Corp. (6701.T: Quote, Profile, Research) and lesser-known rival brands Kyocera (6971.T: Quote, Profile, Research) and Mitsubishi Electric Corp. (6503.T: Quote, Profile, Research) leading the wave of offshore migration for new product development.
Other major players such as Matsushita Electric Industrial Co.'s (6752.T: Quote, Profile, Research) Panasonic brand and Toshiba Corp. (6502.T: Quote, Profile, Research) have dabbled in buying finished phones from Taiwan to sell under their own names, but they still do the bulk of the design work at home for their most important models.
Analysts said the move to offshore design work, which has been a long time coming, mirrors a similar trend at major western rivals and is a critical step if Japanese firms ever want to become serious players on the global stage.
Despite Japan's prowess in many consumer electronics segments, its mobile phone makers command a relatively meager 5 percent of global handset sales away from their home turf, according to market research firm IDC.
LOOKING TO CHINA
IDC analyst Kimura Michito said Japanese players have typically stuck to high-end model design, a factor that has kept them out of many developing markets and limited their ability to become serious global players.
"Their cost structure is too high," he said. "Costs are very high in Japan. If handset vendors want to become worldwide players, they have to be prepared to offer a variety of products."
NEC, Kyocera and Mitsubishi Electric have looked to China in their early steps abroad, forming relationships with China TechFaith Wireless Communication Technology Ltd. (CNTF.O: Quote, Profile, Research), a Beijing-based design shop set up by former Motorola (MOT.N: Quote, Profile, Research) employees.
NEC began working with TechFaith the earliest, setting up a joint venture with the company in late 2003, said TechFaith Chief Financial Officer Eva Hon. Kyocera and Mitsubishi became clients in mid-2004, she added.
"We are talking with some other Japanese companies now," she said, declining to give names. "It's significantly cheaper for them. We usually charge about $1.5 million per model. That's significantly lower than their own costs, maybe eight to 10 times lower."
SOFTWARE POWERHOUSE
Kyocera Chairman Yasuo Nishiguchi said China had been a good design shop for models sold in emerging markets, but the more selective home market could be a tougher nut to crack in the near term.
"For the Chinese market, we have already started out with TechFaith.... The Latin American market will be with TechFaith," Nishiguchi said at the Reuters Asia Technology and Telecoms Summit in Tokyo on Tuesday.
NEC and other Japanese players are also looking to software powerhouse India, joining industry heavyweights Motorola and Nokia (NOK1V.HE: Quote, Profile, Research), which already outsource significant amounts of research and development to Asia's third-largest economy.
In June, NEC formed a joint venture with HCL Technologies Ltd. (HCLT.BO: Quote, Profile, Research), India's fifth-largest software services exporter, to design wireless applications software.
That venture is likely to post revenue of about $25 million by its third year, and has the potential to grow to $75 million to $100 million in sales in five years.
Indian software outsourcing giant Wipro Ltd. (WIPR.BO: Quote, Profile, Research) also counts some Japanese cell phone makers among its large client base in that area, said I. Vijaykumar, vice president for wireless and mobile networks. He declined to provide any names.
"The main reason why global players come to us is because we shorten the time to market for mobile products," he said
tinyurl.com/dekcj
Obviously, pushing out the approval process for 3G licenses will hurt design shops like CNTF that rely on the introduction of new technology for design work. However, this seems like a short term problem as the long run trends are still intact. Plus, if CNTF is successful at getting more outsourcing work from some major international cellphone companies, they could still show decent growth in FY06. I see the 3G design work as an additional catalyst for growth, albeit further out than expected.
I guess the key question is at what point will the stock fully reflect the 3G delay issue. At its current price of $9 and with $3 cash on the balance sheet, I'd say pretty soon but who knows in the current news vacuum??
1. Motorola is going to release $40 cellphone in China next year.
2. Infineon showed its sample cellphone for $30.
If these news are true, it could affect CNTF's revenue since CNTF is
majorly focused on low end markets.
But this could not explain why CNTF drops so much in last two weeks.
Longcheer holdings is a direct competitor of CNTF. It is listed on Singapore
Stock Exchange (L28) and its stock does not drop much in last two weeks.
One thing I don't understand the floating shares. CNTF IPOed 8.7M shares
and the first day trade volume is just 2.34M. So who own the remaining
shares? I checked it in Website and institution just owned about 9%.
Anyone can shed some light on this?
Just my two cents.
Overall, I believe the whole handset market will see a convergence of phone, consumer electronics and software applications. This requires innovative and efficient R&D, which is CNTF's focus and competitive advantage. I have confidence in its ability to get orders. But, I worry that the margin will probably narrow. Its current gross margin, operating margin and net margin are so impressive in any industries. Sure, this fat margin might come from the efficiency of its operation. If that is the case and CNTF can hold onto this strength in the future, its margin will not be affected much. In the long run, I foresee a growing number of orders but declining revenue per order.
Its two Chinese competitors, LongCheer and Sim went public this year in Singapore and HK respectively. As disclosed by CNTF's CEO during the 2Q conference call, those two are not pure play as design house. Their filings seem to confirm this. Anyway, their income statements look much worse than CNTF's. Either CNTF has the ability to get big orders or CNTF is superior in efficiency. But, theie market evaluation presents a harsh benchmark to CNTF. Those two firms are now traded around 8X of 2005 EPS or lower. I think the relatively unfamilarity with the niche (mobile handset design house) contributes a lot to the low evaluation. Investors may think those firms could evaporate overnight in the near future because traditional thinking regards R&D as un-outsourceable.
Based on current information available to the public, I believe the stock has hit its floor value. Any price we see below it may present great Return/ Risk ratio. And, I agree the IPO price and the concensus estimate present an ideal value of the stock if everything goes right for CNTF.
But, if we refer to the valuation of the two Chinese competitors, we will see a further declline in its share price, probably to 6 or 7, which will be a big slap on the face of its underwritters. But, who knows? it seems CNTF attracted some big names including Government of Singapore and its affilated entities. No kidding: the three Singapore entities hold more 5% of the total shares outstanding. Their cost should be over $16 per share. I got confirmation from CNTF's IR that they bought on open market after IPO. It is interesting to see the heavyweight player like that is trapped over there with a huge position. Let us see how this relentless fall ends.
R&D's strength can be measured by Innovation/ Cost, of which innovation is the priority but the cost is also important considering the globalization. Correspoindingly, we can measure a R&D unit's strength via talent/ cost. The ratio clearly points to three regions for the best resources: China, India and East Europe. So, the real threat to CNTF, if not coming from China, comes from India and East Europe. India, as a software powerhouse, has strong presence in the relevant area. HCL Tech, Wipro, Flex (acquring talents in India) are all looking at this niche field. The cellphone design work is 70% software-related as disclosed by CNTF's CEO during the 2Q 2005 call. So, let us see who is the king on software engineering. Although Indians have enjoyed the reputation in the west, my personal experience told me Indians are not that good on computer science as most think. What they really have as advantage is they speak English, a great gift from the colony period. Personally, I believe their education status falls short of that of Chinese. I think as long as Chinese can send people into space walking around (a bundle of technologies that can only be developed by yourself), these guys have the brain to build anything they want either when they were forced to by the government or when the market drives them.
Based on current information, CNTF has an edge on cost at least over FLEX. Let us see who will be ultimate winner.
current market situation.
They already sold 2.6M shares during IPO.
For those who are bringing the stock down these days, I wonder how did they get the shares to short. There aren't too many shares available to borrow, and the short interest is not high either. How did this happen?
Probably the underwriters have enough shares got at low price in IPO deal, and selling at this level they still can make money? But why don't they distribute it slowly at higher price? Or maybe they just dump the shares from one pocket to another. Who knows.
Or, it could be that someone knows some good reasons (that we don't know yet) which confirms the stock should be traded at, say$5-7 level, so they are taking advantage of knowing that earlier and shorting the stock for profit.
I'm also puzzled by the fact that there is no big buyers even at this level. Without issuing real bad news, the company is 50% on sale from its IPO price labelled just a few months ago.
Will be interesting to see...
It is almost becoming a destiny that CNTF will head to the same valuation as its Chinese peers Sim and LongCheer.
So, first let us look at why Sim and LongCheer have such a low P/E. It is primarily because their clients, Chinese mobile terminal brand owners have a very bad year so far. Many of them incur loss while some of them went bankrupt. For an example, Soutec who used to the one of the top five Chinese brand owners had a cash-flow problem which led to the courts froze its operating assets. BTW, Soutec owed money to CNTF too and CNTF wrote off the A/R competely in 2Q. So, considering Sim and LongCheer's clients are all Chinese brand owners, I think it is rational for the investors to value the two at low P/E. Tomorrow they may disappear with their clients on the market together. But, look back at CNTF, 70% of its revenue in 2005 comes from international clients as disclosed by the CFO in the 2Q conference call. I expect the percentage will go even higher in the future as CNTF is doing its best at getting away from Chinese clients (disclosed in the Prospectus and other filings). So, it is rational to value CNTF as comparable international players in the mobile terminal sector of the telecom industry. That will price CNTF as 15x 2006 EPS (a sector average), which gives u hint on why analysts have all pointed to a price target of 15 or something. Here I think I found the answer for why Sim and LongCheer have such a low P/E and why CNTF has followed it so far. But, the real picture shows CNTF is designing for the winners which makes CNTF deserve a valuation like its clients and competitors (like HTC) while Sim and LongCheer are designing for the losers. The market will recognize the difference and give CNTF a proper valuation in the future.
A little more on mobile terminal R&D: let us get realistic about it. The R&D units of the mobile terminal sector are functioming as system integrators who combine third-party hardware and software to offer a final solution. Do they add value in the process? Yes, but it is not that big as most think. What they need to do is to offer a trendy outlook, pratical and easy-to-use functions and assure product stability in manufacturing and usage. The designers of enabling components and software applications plus new network capabilities and attractive content provide more value to the customer's experience with a mobile terminal. So, the innovation here boils down to a little bit creativity (mainly enabled by third-paty innovations) and quality. Why quality plays such an important role here? Get back to Chinese brand owners: they have the cheapest price on the market and have the worst product quality also. The latter kills them, not their products' mimic outlook and generic funtions. So, the whole thing let me questiion what R&D units at international brand owners are doing. It has been referred by many sources that designing a new model cost them at least 10M dollars, while CNTF can get it done by 1.5M with a 45% net margin and FLEX can do it with 3M. So, outsourcing a highly-inefficient internal function which adds moderate value makes perfect sense. The future is bright for CNTF and its competitors who will help the sector achieve a better economic structure. Brand owners will focus on sales and marketing and supply chain management like what Dell does. Under this backdrop, do the prominent design houses deserve a P/E like its clients?
At the same time, I expect we will see more players enter the mobile terminal segtor in the future. A strong force is network operators. Their networks put them most close to the end users. Almost all the cool functions and rich content have to be delivered through the networks, which make them most interested with integrating the terminals into their product portfolios. They tend to offer the machines that are best catering to the network capabilities and content offerings. This makes perfect sense. Why use Nokia and Moto since it is so easy to get a customized terminal by just calling a design house like CNTF and a EMS like FLEX? On the other side, Dell and HPQ will join the force since they will see the small terminal performs more fuctions of a PC and they know it is the future form of PC or whatever you call it. The No. 3 PC sellers in the world, Lenovo, already joined the race and it fares pretty good as one of only two Chinese mobile terminal brand owners who make profit so far this year. Its supply chain for PC must have functioned well for the cellphone also. So, it makes sense for PC vendors to join the race to proect their turf. This is certainly a good news for CNTF and its competiors. Get back to CNTF's edge: now I adjust it to design quality/ cost considering mobile terminal's R&D process is heaviy dependent on third-party innovations (design quality should assure product's stability in manufatcuring and usage after meeting client's feature requirement). So, the segment reminds me of an industry that has fuled China's growth in the past 20 years: manufacturing outsourcing service. Since it is just a low-end R&D process which emphasizes cost after assuring quality, will Chinese be the king of it? You tell. I think they will. CNTF already told you: they offer the cheapest price available (from public sources) and still enjoy a 45% net margin. Should investors benefit from this new trend of outsouring to China? We will see.