To many investors the notion of investing in Chinese equities remains anathema. At IPI, however, we have noted recent developments in the China space which suggest the emergence of some early "diamonds in the rough". After watching China mobile-media play, Kongzhong Corp. (KONG), double over the past six months, our interest in China was further piqued by the observation that noted short-seller, Citron Research, has dramatically backed away from shorting China stocks in 2012. In fact, Citron has actually gone as far as recommending Sohu.com (SOHU) on the long side. In Monday's trading, Baidu (BIDU), the China 25 Index (FXI), and Spreadtrum Communications (SPRD) each experienced significant accumulation, pointing to a major long-term bottom for these names. Perhaps the time has come to sift through the rubble?
Hoping to cull our search results down to one prime candidate, we screened for a Chinese company with the following sterling investment attributes:
- A disruptive and differentiated technology, buttressed by a strong patent portfolio.
- A secular opportunity being funded and promoted by the government.
- A management team endorsed by the government, where the CEO has the ear and backing of government officials.
- A partnership with one, if not two, of China's Fortune 500 companies.
- A clean balance sheet with strong working capital, along with a capital structure that would not require substantial dilution.
A stringent list to be sure. After much due diligence, however, our search led us to the Chinese electric vehicle manufacturer, Kandi Technologies (KNDI). While Tesla Motors Inc. (TSLA) has become a media darling for its EV efforts here in the States, in China, Kandi has begun to garner positive press of its own. Let's discuss why.
In addition to positioning themselves to be one of the main suppliers, if not the sole source provider, for the 20,000 EVs in Hangzhou's rental program, Kandi is also on the cusp of additional expansion and new contract wins in new provinces. Moreover, its partnerships with two Chinese Fortune 500 companies, the State Grid and the Aviation Industry Corp. of China, not only validate the company's IP and technology, they also position Kandi to receive an additional, high-margin revenue stream for its patented QBEX (Quick Battery Exchange) technology. As these positive events unfold, we feel Kandi has the potential to return both 60%+ by year-end and multi-bagger gains over the longer-term as it seizes market share and ramps to an annualized capacity of 100k electric cars by 2015.
To fully comprehend how Kandi has arrived at its current position of strength, investors should know that KNDI's CEO, Mr. Hu, has been strategizing for years with China's highest ranking government officials who have been tasked with the long-term planning of China's EV industry. In our view, most U.S. investors have overlooked this key element to the story.
Mr. Hu's long history with China's EV sector began when a government sponsored company, Universal Electric Motor Co., Ltd, initiated four electric vehicle projects in 2006. Mr. Hu spearheaded the very first project. His involvement with this early project allowed him to mold Kandi's business model and tailor it to the very same initiatives the Chinese government would eventually favor and endorse.
While many may scoff at the diminutive size of Kandi's EVs, the Chinese government considers these compact cars to be an optimal use of resources, while simultaneously reducing current traffic jams. In addition, it is important to understand Kandi's cars are just one cog in the planned EV eco-system in Hangzhou, the first pilot city for EV rentals. Consider that:
- Kandi's partnership with State Grid is a centerpiece of Hangzhou's electric vehicle plans. The State Grid, China's second biggest utility, is responsible for the build-out of charging stations and the smart grid integration of the EV power supply.
- Kandi has also partnered with Global Fortune 500 Company, the Aviation Industry Corp. of China (OTC:AVIC), in Hangzhou. AVIC's subsidiary, China Aviation Lithium Battery, will be responsible for producing automobile-use lithium batteries and for purchasing 20,000 EVs for personal leasing.
- The Hangzhou municipal government will provide generous financial subsidies and also create policies to spur interest and demand for EVs.
- Kandi has been tasked with supplying the 20,000 cars, with 1,000 cars to be delivered from September to December of this year and 2,000 cars in each of the first eight months of 2013.
Kandi has been diligently preparing for this moment since its formation in 2006. The company's most recent 10-k highlights many of the accomplishments achieved over the past 12 months. These include:
- In August of last year, Kandi spearheaded a task force designed to study the feasibility of building a 100,000 pure EV rental network in Hangzhou City and the related supporting policies that would be required to make this a reality.
- On February 29th of this year, the Ministry of Industry and Information Technology of China issued the "Energy-Saving and New Energy Vehicle Demonstration and Promotion for Use Project" list. Kandi's pure electric cargo vehicle, KD5021XXYBEV, was included on this list.
- On March 6, 2012 the Ministries of Finance, State Administration of Taxation and Industry and Information Technology of China, collectively issued a list of Energy-Saving and New EVs which qualified for the Registration Tax Reduction and Exemption policy enacted earlier in the year. Kandi's EV was among the first vehicles included on this list.
- In late May of this year, Mr. Hu presented his vision for a 100,000 Pure EV Network in Hangzhou. A key element of this plan involves a "smart" and automated parking system, which will be equipped with automatic charging stations. The fully integrated system will also supply maintenance of the EVs, parking, and an energy supply. Kandi has the patents for this plan.
Perhaps the most noteworthy aspect to this Pure EV Network plan is how little land will be utilized. Only 0.5 square meters of space will be required for each vehicle. This equates to 200 vehicles being able to park in 100 square meters of space.
Not surprisingly, Mr. Hu's vision was endorsed by various Chinese leaders, including Mr. Qingtai Chen, the former secretary and deputy director of leading Party group of Development Research Center of the State Council; Mr. Weidou Ni, president of the China Energy Society; and Mr. Yi Lin, Chairman of the New Energy Vehicle Co. of Beijing Automotive Industry Holding Company.
If you consider Kandi's momentum as it heads into this weekend's EV symposium, the partnerships it enjoys with two of China's biggest companies, and its central role in Hangzhou's EV development plan, it stands to reason Kandi will be the sole manufacturer of EV's for this program. Nonetheless, Kandi has yet to issue a definitive press release confirming the contract win for the 20,000 cars. Instead, a few weeks ago, the company issued a confusing press release stating it had secured a Letter of Intent to promote the rental of 20,000 EVs in Hangzhou.
Why would Kandi issue such an oblique press release for what appears to be its most important contract win ever? It made no sense to us, so we asked around. From what we could gather, this is a customary business practice in China when a partnership is struck between two companies of disparate size. In such instances, where a small company secures a contract win with a larger corporation, it is customary for the smaller entity to remain silent until the larger company has been able to announce the partnership first and enjoy the positive press of such a contract win.
With this being so, the next logical question that arises is when investors should expect Kandi to officially announce the 20k car contract in Hangzhou? While one might expect the company to announce the win at this weekend's EV Expo, Mr. Hu might consider it more prudent and respectful to delay the news until after the Expo is over. But however Mr. Hu elects to handle the situation, the news will need to emerge soon if Kandi is to stay in compliance with the SEC's Regulation FD, which mandates "full and fair disclosure." So, we believe confirmation of the contract win is coming shortly.
Thanks to Google and Google Translate, a few other discerning investors have been able to aggregate the important data and put the pieces of the puzzle together. Noted alternative energy blogger and Forbes columnist, Tom Konrad, is so confident Kandi will be the sole supplier of the 20,000 EVs, he has published three articles on Seeking Alpha detailing the significance of this contract win. Last weekend, electric vehicle and transportation Internet site, EV World, also confirmed that Kandi had secured the order.
While these columnists deserve credit for "breaking the news" on the contract win, we believe the true accolades should fall on the incredibly shrewd group of investors on KNDI's private message board. Over the past six months, we have quietly watched these sleuthing investors build a very credible case for Kandi and its chances for winning this contract in Hangzhou. Work well done gentlemen - our thanks!
In our opinion, two individuals deserve particular praise for their extraordinary efforts: Art Pocari and Marc Chang. While Art was too early to the story, you must give him credit for his confidence and perseverance in believing in Kandi. Marc Chang also deserves to be singled out for his impressive work on a four-part Kandi series published last December on Seeking Alpha. Marc's research was extremely thorough and his thesis on KNDI was both intelligent and perceptive. His four-part series is one of the first places new investors should go to perform their own due diligence on the name. A seminal piece of work, Marc. Well done!
Taken as a whole, it seems abundantly clear Kandi has been groomed to be China's electric vehicle "Golden Child". The smart money seems to concur, as KNDI's stock has risen to 52-week highs over the past two weeks. In our opinion, this is just the beginning of the move for KNDI. As mentioned earlier, we see 60% upside potential by year-end. While a $7.50 price target might seem lofty to some, consider these compelling reasons for our bullishness:
First, at around $6800 a vehicle, the total dollar value of the 20k EV Hangzhou contract amounts to $136 million. With Kandi's legacy business on an annualized run-rate of $45 million, this contract will immediately triple the size of the company. As such, the Hangzhou win will meaningfully accelerate Kandi's top-line and bottom-line numbers immediately in Q3. When these numbers are reported, they should show an almost 100% increase in the company's top-line to $18-$20 Million for the quarter and at least a tripling in underlying year-over-year profitability. Q4 should show about $30 Million for the quarter and a 400-500% increase in earnings growth year-over-year.
These eye-opening quarterly results will usher in the next round of institutional investors into Kandi's stock. This is where things should get very interesting. With only 30 million shares outstanding and just 17 million shares in the float, (Mr. Hu owns 43% of the company) new investors to the story will be forced to pay up for KNDI's stock. A move above all-time highs at $7.25 seems like a reasonable target by year-end. Take a look at the chart below. KNDI is currently breaking out of a Cup n Handle pattern, with the next logical price target the blue dotted-line around $7.25-$7.50:
KNDI 5-Year, Monthly Chart
By December, institutional investors will be looking ahead to 2013, Kandi's break-out year. With 16,000 cars due to be shipped in the first eight months of next year, Kandi cannot help but demonstrate explosive growth next year. Tom Konrad thinks KNDI can earn $1.20-$2 a share in 2013. We are not going to argue with those estimates. Along the way, Kandi should also benefit from higher margins as the company ramps up production to 6,000 cars a quarter, beginning in Q1. Revenue should more than double next year to $150 Million. As is always the case with companies posting record growth, new institutional interest will swell in the name, pushing Kandi's stock into the low double-digits by next Spring-Summer. As this transpires, we would expect to see one or two analysts initiate coverage on the stock as well.
Assuming success in Hangzhou, Kandi should begin to land additional contracts for other EV programs by next year. This process has already begun, with the company recently landing a massive contract win in Shandong province for 20k-100k cars a year, beginning in late 2014. As we look ahead to 2014-2015, it does not seem unreasonable to expect KNDI to be able to ship 50k-60k cars in 2014 and 100k cars in 2015. One hundred thousand cars in 2015 could represent a 40% EV market share for KNDI.
While it is too early to know for sure what 2014-2015 holds for the company, from where we sit in 2012, we believe Kandi's potential is vast. If the company can execute and the government continues to subsidize the EV sector, KNDI could offer investors a 10-bagger return by 2015.
As with any stock, there are multiple risks. For one, China's government could pull back on subsidies if consumer demand for EV's does not materialize. There is also execution risk and timing risk. It has taken awhile to get to this point and there is no guarantee that the government will be able to get 500,000 EV's on the road by 2015. Having acknowledged this, we still like the risk/reward at current levels - downside seems very limited, while upside appears quite large.
It should be an eventful couple of years for Kandi and we look forward to being part of the ride.