Linktone (ADR: LTON)
Cash & Short term investments per share
Total liabilities per share
Net cash and Short term investments
Upside to net cash and st. inv.
Cash & ST Inv.
Wireless value added service provider (games, ringtones, screen savers, applications, etc.) in the midst of a turnaround. They develop, market, and distribute content and applications for mobile and fixed line network operators in China and have goals of expanding into Indonesia and the Philippines. They had a decent run from 2003 to 2006, growing revenues from $16m to $76m but in 2007 revenues declined 31% to $55 million after Chinese telecom regulators changed some of the mobile operator policies to protect consumers. Specifically, service providers had to issue double confirmations for new subscriptions and were required to send reminders to existing monthly subscribers on fee information and automatically cancel inactive subs. Despite the policy change, revenues rebounded in 2008 to $64.5 million but net income was negative due to costs associated with the termination of a cross-media business they entered in Q4 of 2006.
In Q4 of 2006 they began to develop traditional media channels and combine them with their existing wireless platform. The idea was to offer TV services over wireless devices and collect ad revenue. They became the exclusive advertising agent and primary content provider of Qinhai Satellite Television, or QTV, and the exclusive ad agent for specific time slots of Tianjin Satellite Television, or TJSTV, both of which operate satellite TV channels in China. They terminated the arrangements in September of 2008 to focus on their core telecom value-added services business or VAS business. In hindsight, management would probably agree the foray into the media business was a mistake.
The collapse in revenues due to policy changes, the unsuccessful venture into the media business, and the decline in the market (which ultimately led to Piper, Collins Stewart, Deutsche, and others all dropping coverage, likely because the market cap became so small) took the stock from over $5.00 to $0.80 cents per share at the end of 2008. By Q1 of 2009 the company was in turnaround mode. The chairman of the board took over as CEO and re-installed the CFO who was with LTON through the primary growth years (June 2005 – January 2008).
Since new management took over, three of the last four quarters have been profitable. This is a respectable accomplishment considering the company had six consecutive quarters of negative earnings under the old management team. On recent earnings calls management mentioned they are considering small acquisitions to help them expand into Indonesia and the Philippines. Management also discussed the possibility of a buyback.
Since last quarter, LTON has made two small acquisitions. In January of 2010 LTON entered into a definitive agreement to acquire a controlling interest in Letang, Game Limited, a private Chinese company specializing in the development of mobile games and PC online games. Letang offers a portfolio of games that can be played on major global mobile phone systems and platforms including Flash, Android, BlackBerry, iPhone and KJava. Linktone agreed to pay up to $9.15 million to acquire 50.01% of the equity. Letang will receive $2.56 million in cash at the closing of the acquisition with the remainder of the consideration payable upon the achievement by Letang of certain financial milestones during 2010 and 2011.
On March 23, 2010, LTON announced that together with its majority shareholder, PT Media (MNC), they completed the acquisition of 75% of the share capital of InnoForm Group, a Singapore based company specializing in the development, distribution, and licensing of edutainment and entertainment products. LTON and MNC will pay $7 million and will receive 50% and 25% of the share capital of InnoForm, respectively.
Despite improving fundamentals and growth opportunities, the stock continues to trade at a depressed level. The table below shows FCF with and without the effects of the discontinued media business.
Click to enlarge
Reasons to own
- $2.36 in cash and short term investments per share and stock trades at $1.59.
- Best comp out there trades at over 2x sales and over 1.5x book. That would make LTON a double.
- EV/EBITDA not very useful at the moment for LTON because they are still in the process of changing the cost structure after terminating the media business. More valuation notes are below.
- Major player in Chinese mobile phone market which has over 700 million subs and penetration is estimated to be only 50%.
- Indonesia represents attractive opportunity and they have cash to spend on small acquisitions to gain a presence.
- New CEO and CFO and two board departures leaves a fresh team at the helm.
- One board member who resigned was replaced by Oerianto Guyandi, a director of the largest and only integrated media company in Indonesia. Formerly he was a director at Bhakti Investment, the largest investment company in Indonesia.
- Note Bhakti was founded by the former LTON chairman, now the CEO.
- Exiting advertising business and focusing on wireless value added services.
- Management considering obtaining approval for a buyback.
- Acquisition risk
- Regulatory risk (wireless industry policy changes in China)
- Related party transactions by prior management. An $11.5m loan to affiliated parties made under prior management is still outstanding and raises questions regarding the shareholder friendliness of certain board members.
- LTON depends on contracts with a few large Chinese telecom providers, specifically China Mobile, China Unicom and China Telecom.
- Dilution. The share count nearly doubled under the old management team, increasing from 24m to 42m since 2007.
- Concentrated shareholder base. PT Bhakti Investments, the largest Indonesian investment company (which happens to have been founded by the current LTON CEO), owns 57% of total shares outstanding. This could be considered a positive as insiders are aligned with shareholders, but if this stake was sold it would put significant pressure on the stock.
- Limited float so illiquid. An average of 45,000 shares trade a day. At the current price of $1.59 that is only $71,550 dollars a day.
LTON is priced for bankruptcy even though the underlying business is profitable. In my opinion, a profitable business with immaterial future contractual obligations should not trade at over a 30% discount to the net cash on its balance sheet. Considering the risks, a fair upside target may be the elimination of this discount, but It doesn’t seem unreasonable to assign the company a multiple considering their growth prospects. If management is successful returning the business to profitability, it seems reasonable to believe LTON should receive a multiple in line with its closest peer, KONG, which currently trades at 7.4x Ebitda but has averaged 14x since 2005.
Before prior LTON management entered the media business, EBITDA margins and net income margins were over 20%. 2010 revenues should be roughly $65m and 2011 revenues should be over $70m. If management can get to 10% margins again, they should generate roughly $7m in EBITDA in 2011. Adjusting for the $100m in net cash on the balance sheet and acquisition commitments of roughly $6m, yields a target market cap of $142m, or roughly $3.40 per share (114% upside). This assumes very limited revenue growth. If management is successful entering Indonesia, revenues should be much higher.
Disclosure: long LTON
Disclosure: Long LTON