Initiating a Position In Gigamedia Before Tuesday's Earnings Report

If you have been reading some of my investment thesis on my core holdings, you have probably noticed that there are some major themes that I like:

-- Consumer Services
-- Internet
-- The emergence of China as the new "consumer superpower"
-- Gambling

Gigamedia (GIGM) cuts across all four of those investment themes and puts them in the "sweet spot" for my portfolio. When I first started following the company earlier in the year, the stock was trading between $14 and $16 per share which was fully valued in my mind.

However the recent downturn has hammered GIGM down to under $11 per share which is around 17x this years earnings and only 12.5x 2008's estimated earnings. Its PEG ratio is only 0.40 making it one of the cheapest high growth company's that I own.

The Company and Business Model
The Company's main business is gaming software which they license to operators of internet based casino and poker site. Most of their revenue currently comes from Continental Europe but they are rapidly adding licensees in Asia, including a new Mahjong site. Longer term, I expect most of their gaming software revenue to come from the burgeoning Asian internet gambling markets.

The Company also operates the largest web-based casual game network in Asia and has been adding additional games and platforms through recent acquisitions. This business is growing very rapidly and will it is only about 1/5 the size of the gambling operation currently, it is expected to grow faster during the next couple of years.

Lastly, the company has a small internet connectivity business that provides internet access to consumers in China. I would expect the Company to sell this business in the future as its two main business grow.

Unlike CRYP and several of the other web-based poker software companies, GIGM never received any material revenue from US-based consumers. As a result, it is not experiencing a down year -- rather it is expecting growth of about 24% this year and another 36% growth next year. The lower growth this year is attributable to some pre-marketing costs associated with a couple of new casual games being introduced later this year.

Investment Considerations
Strengths
China - The company is well positioned to grow rapidly as the emerging middle class in China becomes increasingly web savvy. Asians relish gambling as entertainment and that should lead to long-term growth for the company.
Internet Gambling - Worldwide internet casino revenue is expected to grow from $2.4 billion in 2006 to $4.2 billion in 2012.
Strong Balance Sheet - GIGM has about $0.50 of cash per share (net of debt) which is about 5% of the current price.

Risks
Political/Regulation - Gambling is subject to national and local jurisdictional rulings and growth will continue to be affected by political issues within different regions of the world.

Valuation
The Company is currently trading at about 18x trailing, 17x 2007 estimated and 12.5x 2008 estimated earnings. And yet the company is expected to grow earnings 24% this year and 36% next year.

During the next 5 years earnings are expected to grow between 30% and 40% annually putting its current PEG ratio (PE/G) at about 0.40. To put this in perspective, large consumer staples like Coke typically trade at PEG ratios above 2.0.

This is another rare opportunity to purchase a fast growing company at discount prices.

Earnings are expected to be released on Tuesday. I decided to buy in advance of the earnings because I felt there was much more upside risk in the earnings release than downside risk.

Disclosure: author is long shares of GIGM.

GIGM 1-yr chart: