Telestone Technologies (TSTC) is a Chinese provider of wireless local-access network technologies, mostly to the "Big 3" Chinese wireless firms: China Unicom (CHU), China Mobile (CHL), and China Telecom (CHA). Telestone still derives most of its revenue from offering these companies traditional RF-based wireless products, but expects to begin generating an increasing portion from its next-generation wireless distribution system, dubbed WFDS.
WFDS is an all-optical network that combines the technologies of both wireless and optical telecommunications to support all mobile telecom networks as well as various other networks, including traditional telephone and video surveillance systems. The company claims this broad solution should appeal to a different customer base -- namely, property developers directly rather than going through the large telecom carriers, and thus should both grow and diversify its revenue streams.
Such a promising technology would be expected to involve a great deal of research and development. In fact, the company says in the first section of its annual report that it has "over 100 R&D specialists, many of whom are industry experts in telecommunications -- all have at least a bachelor's degree, and 40% have a master's degree or above." With such an extensive R&D department, you'd expect the company to devote a large budget to it. However, for each of the past two years, the R&D spending reported in the company's annual report has been just over $2 million, with the latest quarter coming in at a mere $567,000. If Telestone really does have more than 100 highly qualified workers at this cost, it would work out to annual salaries of less than $23,000 per employee.
While labor is indeed cheaper in China, Forbes has noted that salaries for many professional positions have increased to near-U.S. wage standards. This means that if Telestone only employs one low-end salaried R&D director at each of its three research centers, this would eat up 13% of its entire R&D budget, leaving less than $20,000 per year for each of the other highly qualified employees. This is not even taking into account the overhead to run all three of the advanced research and development centers, which are supposedly "equipped with the latest equipment and testing facilities" according to the R&D section of the annual report.
Let's contrast Telestone's R&D spending with another Chinese tech company that I have much more faith is legit, Actions Semiconductor (ACTS). Actions' R&D budget has been over $17 million in each of the past four years and over $5.6 million in each of the past two quarters, going toward paying a staff of 540 research and development engineers. This works out to an average annual salary of about $41,500, almost double what engineers at Telestone could possibly be making based on the total R&D budget, despite the fact that Actions does not make the same grandiose claims that they are all experts with college degrees.
I am certainly not the first to bring up this issue, but I thought it and other red flags still have not been adequately put to rest more than a year later. Most notably, Telestone is still struggling with keeping its accounts receivable under control, which have ballooned to over $260 million in the last quarter. This represents an astounding 1,232 days sales outstanding (DSO), meaning it will take the company over three years to collect these accounts receivable, unless it can do something similar to what Yongye International (YONG) recently did and somehow miraculously collect all overdue accounts at once.
The company insists that this is the nature of its business and that the major telecoms are notoriously slow with payments. However, all the "Big 3" annual reports show no accounts payable outstanding that are not due within a year. Also, in the Accounts Receivable heading of this section of the annual report, Telestone itself says "once a contract is signed, we receive 60%-70% of the contract value within four to nine months, another 20%-30% in nine to 12 months, and the remainder in 12-24 months."
Therefore, Telestone should be turning these receivables into cash flow at a much faster rate. For example, since prior to 2011 99% of all sales came from the "Big 3," at least 80% of the accounts receivables outstanding at the end of 2010 should have been collected by the end of 2011. However, examination of the annual reports actually shows an increase in accounts receivable from nearly $200 million at the end of 2010 to over $250 million by the end of 2011. Since the company books revenue as soon as a contract is signed, the $110 million in 2011 revenue would be expected to be added to accounts receivable. But this still doesn't even cover the $160 million that should have been collected, and we would have expected for accounts receivable to decrease by $50 million instead of increasing by that same amount, unless it has been consistently overstated.
These discrepancies seem to indicate that Telestone is at best a technology company with an underfunded R&D department and thus probably not much of a competitive advantage to continue winning contracts from companies that it seems to have trouble collecting from anyway. At worst, it's another unfortunate example of a Chinese company with financial issues. So I would urge others to steer clear of this stock until the smoke has cleared and these inconsistencies have been explained.
However, I have not shorted the stock or written this article on behalf of anyone that has, as I do not want to be accused of engaging in a "short and distort" or any other similar scheme. I am merely pointing out some unsettling facts in a stock that has enjoyed a noticeable rebound lately, rising over 50% in the last month, so I wanted to try to make sure it doesn't attract new investors who are not aware of some of the previous accusations against the company. I would encourage all potential investors in Telestone, whether long or short, to engage in further due diligence and hopefully some intelligent discourse to try to address these concerns.