With China's rapid growth, the country's physical and financial infrastructure is having difficulty keeping up and the Chinese and Hong Kong stock markets are two examples of the bottleneck. There is a waiting list to undertake an initial public offering on both of these exchanges that can be as long as 3 years.
As a result, many of China's growing companies are coming to the US NASDAQ market for growth financing. Most of the time these companies are too small, or have not yet fulfilled all the accounting and board-related requirements for full NASDAQ listing and thus they end up on the OTC bulletin board.
Herein lies the opportunity for investors; uncover thinly followed on the OTC bulletin board with large growth potential. I have taken a position in China Security & Surveillance Technology (CSCT.OB) as just such an opportunity. I took my initial position a few weeks ago and just today the Company announced that it received approval for listing on the NYSE. This will dramatically increase awareness for the Company.
Company and Business Overview
CSCT is building one of China's largest players in the security and surveillance space. The Company designs, manufactures and installs primarily video surveillance both to private business and governmental bodies throughout China. The Company has installed systems for governmental buildings, factories, bankings, border crossings, universities and transportation systems. In the future the Company also intends to add monitoring services for customers.
The Company has been highly acquisitive in the video surveillance space both to acquire complementary technologies as well as grow geographic breadth. CSCT currently has over 200 salespersons in over 59 distribution points across China.
Revenue and profits are growing dramatically both organically and through acquisition. Revenue and Net Income grew from $16.1 million and $5.7 million, respectively in 2004, to over $106 million and $22.9 million, respectively in 2006. For 2007, analysts expect the Company to surpass $200 million in revenue and $35 million in Net Income.
In addition to general economic growth throughout China, CSCT is also benefiting from several governmental efforts to increase video surveillance throughout the country. With the Olympics coming to China in 2008 and the Shanghai World's Fair in 2010, the government has issued New Public Security Ordinances that require the 660 largest cities in China to install City Safety surveillance systems in major public venues such as subways and municipal buildings.
Management is estimating the total market opportunity for these governmental initiatives at over $25 billion. The opportunity does not end with the governmental facilities, though, as State Ordinance 458, requires all entertainment venues in China, such as cybercafes, pubs, discos, etc to install electronic eyes. China is taking a leading edge on the prevention of terrorism and I think CSCT will be a major beneficiary.
Finally, while the Company does not currently offer monitoring services, they are simply waiting for the network of installed systems to reach critical mass and then they plan to offer those services. This will add a recurring revenue stream that management believes will be added in 2008 or 2009.
Large Potential Market - China, the world's largest population, is growing rapidly and the Chinese government is leading the world in requiring video surveillance throughout its major cities. The Company is at the right place at the right time.
Thinly Followed Company - As an OTC bulletin board company, CSCT gets very little Wall Street coverage and as a result the Company is undervalued relative to its growth rate.
Catalyst for Discovery - The Company will not be thinly followed for long as it recently received approval for listing on the NYSE. This will open the Company's stock up to a host of institutional investor and the valuation should increase closer to fair value.
Remote Investment - Investing in a remote country, such as China, is riskier than investing in growth companies here in the US. I require a larger margin of safety (discounted valuation) when investing in riskier opportunities, but CSCT's current low valuation provides that added margin of safety.
Analysts expect the Company to earn $1.05 per share in 2007 and $1.50 per share in 2008. At $17.48 the Company is trading at only 16.6x 2007's EPS and only 11.6x 2008's EPS. I feel the current valuation provides a very large margin of safety to the Company?s expected growth rates of nearly 50% for 2008.
Earlier this year, Citadel, one of the largest hedge funds in the US, purchased $60 million of convertible notes from CSCT. Citadel's conversion price is $18 per share, so I also feel pretty good about investing at a similar buy-in price as one of the best performing hedge funds in the US.
Disclosure: Author is long CSCT.OB
CSCT.OB 1-yr chart: