Seeking Alpha
Profile| Send Message| ()  
China 3C Group (CHCG-OLD) is a distributor which operates using a “store in store” concept in Eastern China. Based on company guidance of $1B in revenue by 2010, the company is worth $16.38 per share using a discounted cash flow valuation.

Recommendation: UNDERVALUED

Investment Thesis:

China 3C Group combines two of the most powerful catalysts for share price appreciation: earnings growth and China. CHCG expects to operate 4,000 stores and generate revenue of $1B by the year 2010. If the company meets these expectations, revenue will grow at a 61% rate. China 3C Group trades at a discount for two reasons: [1] the stock is listed on the OTC Bulletin Board; and, [2] being based in China creates a dearth of information on the company.

Catalysts:

1.) AMEX listing: China 3C Group applied for listing on the American Stock Exchange on January 15, 2007. Listing on the AMEX would supply greater prestige for CHCG. Such prestige would generate share price appreciation because such a listing would increase investor familiarity.
2.) Information: Once the company is listed on the AMEX, more information on the company should be readily available. This will help determine whether growth estimates are realistic or blue sky estimates.
3.) Chinese Economy: Currently, China is experiencing unprecedented economic growth. If a recession were to hit the Chinese Economy, CHCG would be adversely affected.

rubischcg

Valuation:
The discounted cash flow method of valuation works best in analyzing China 3C Group. Relative analysis is nearly impossible due to difficulty in determining what industry CHCG belongs to and who its competitors are.

Table 1: DCF Valuation of China 3C Group Using Company Guidance
rubischcg1

The table above illustrates the value of China 3C Group using management estimates for growth over the next four years. Management committed to operating 4,000 stores and generating $1B in revenue by 2010. This guidance suggests a 61% rate of growth, which can be calculated using the rate function in Microsoft Excel, or any financial calculator. The model assumes a more modest rate of growth, roughly 17%, for the years 2011 through 2016. Our model assumes a risk free rate of 7% and an unlevered beta of 2. These assumptions take into account default risks associated with foreign markets, and the volatility of equity prices for companies listed on the OTCBB.

Table 2: DCF Valuation of China 3C Group Using Conservative Growth Estimates
rubischcg2

Table two illustrates what CHCG is worth using more conservative growth estimates. This DCF model assumes a 17% rate of growth well below the 61% in our first model. The model in table two assumes a risk free rate of 7% due to default risks associated with foreign investments and an unlevered beta of 1, since the model uses a more conservative growth estimate.

Table 3: Relative and Other Valuation Methods
rubischcg3

The relative valuation presented in table three uses the electronic stores industry for industry averages. China 3C group does not perform favorably using these valuation methods. From a P/E perspective CHCG is undervalued, but the stock trades at a premium in terms of price to sales and price to book value. These values as well as earnings power value are misleading because the company expects to achieve exponential growth over the next few years. Values presented in table three are interesting but do not provide an adequate assessment of the investment opportunity in China 3C group.

Business Prospects / model:
China 3C Group is a consumer electronics distributor, which operates nearly 800 stores in mainland China. The company distributes mobile phones, facsimile machines, DVD players, stereos, speakers, MP3 and MP4 players, iPods, electronic dictionaries, CD players, radios, Walkmans, and audio systems. China 3C Group expects to see strong growth from the mobile phone market over the next few years. The company has committed to operating 4,000 stores that generate $1B in revenue by 2010 [see company website].

In 2006, CHCG saw strong organic sales growth from its YYWC and HWDA subsidiaries. Each subsidiary grew revenues by 122% and 480% respectively. The company utilizes an acquisition strategy to compliment its organic growth of existing subsidiaries. CHCG acquired Hangzhou Sanhe Electronic Technology, Limited and Shanghai Joy and Harmony Electronic Development Co., Ltd. These newly acquired subsidiaries contributed $35M in revenue to CHCG in 2006.

The following chart describes the structure of China 3C Group’s subsidiaries.

Chart 1: Operating Structure of China 3C Group and Subsidiaries
rubischcg4

Special Circumstances:
Equity Private Placement

Some analysts believe that the recent private placement of equity in CHCG raises red flags. Shares were sold at a discount to current prices, $5.60 per share, which we find reasonable. Such a discount is to be expected because CHCG trades on the OTC Bulletin Board. If the company were listed on the AMEX or NASDAQ, such a discount would be questionable. The discount represents the liquidity risk that the investor undertakes by providing capital to an OTC BB stock.

Best Buy (BBY) Agreement
This Forbes articles gives investors confirmation that China 3C Group might be a legitimate company. Best Buy came to an agreement with CHCG to provide consumer electronics goods for Best Buy’s new store in Shanghai.

Disclosure: *CHCG is a highly speculative investment because of its listing on the OTCBB exchange. The company's location in mainland China makes it difficult to verify and obtain information on the company. The author cannot be held responsible for any monies gained or lost on trades undertaken based on information presented herein. The author currently owns: Agilent Technologies (A), Brasil Telecom S.A. (BRP), Biotel, Inc. (BTEL.OB), ChipMOS Technologies Limited (IMOS), and ConocoPhillips (COP).

Source: Valuation Analysis: China 3C Group