I wanted to point out one of our holding, China Education Alliance, Inc. (CEU), which we believe offers investors a high return potential and a big margin of safety. The company offers exam preparation materials and vocational training, both online and on-site. We like the business model because as it offers high margins on very low cap ex and thus generates great free cash flow. The industry is also attractive with both the government and parents placing great importance on education.
The company recently announced impressive results for Q2 2010 with sales growth accelerating to 33.7% ($10.85 mm in Q2 2010 vs. $8.12 a year ago) and net income growth of 30.8% ($4.26 mm in Q2 2010 vs. $3.28 a year ago). Management forecasted that the trend will continue and guided for 30% annual revenue growth for 2010 as a whole. CEU is expanding geographically by opening new training centers in other provinces in order to bolster growth. They are also actively looking for acquisitions but have a history of prudence in this regard having always patiently waited for great opportunities at low valuations.
CEU closed the quarter with a huge cash balance of $74.7mm or $2.20 per share. The stock currently trades at 7.2 times the 2010 earnings estimate (we believe these estimates are too low). Backing out the cash the stock trades at only a 3.7 times 2010 estimates. We view this as too low of a multiple and think that the stock could be worth 15x 2010 earnings, or above $9 per share.
As a validation of our valuation target we would point to two of CEU's piers in the Chinese education industry; New Oriental Education & Technology Group (NYSE:EDU) and ChinaCast Education Corporation (OTCPK:CAST). EDU trades at 36 times earnings estimates for its fiscal year ending in May 2011 and CAST trades at 15.6 times 2010 earnings estimates.
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Disclosure: Long CEU.