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NQ Mobile (NQ): Paying 5x P/E For Feiliu Is Too Low To Be Credible.

As I previously analyzed, NQ's security business doesn't generate much free cash flow (after all the acquisitions) despite strong revenue growth and high margin. That is fact. And interviews in China show no users of NQ security software there. That is an incomplete observation, but stands in big contrast to NQ's 60-70% market share claimed for China. And you are encouraged to check with your own Chinese friends. The new 20F shows that one distributor, Tianjin Yidatong, brought in 47% of China consumer security revenue, up from 46% in 2011.

Now that Feiliu enters the picture, can it change NQ? Mobile game platform business is supposed to have high growth, high margin and real cash flow in China.

Exactly how big is Feiliu's revenue? In NQ's 20F filing, it indicated that Feiliu only started to get mobile gaming revenue in 2012 (it was previously a mobile appstore), and its contribution in 2012 was $664K in revenue (for Dec), which equates to $8M, if multiply by 12 months. The actual 2012 mobile game revenue of Feiliu is likely <$8M since the revenue probably grew throughout 2012.

For 2013, NQ management forecast Feiliu to be $25-$28M. So that's 3x-4x 2012 amount. Very strong growth! And mobile game platform is supposed to have high margin. 40% on the net margin should not be too much for such a business. So this will be about $10-11M in net income.

For this high growth high margin mobile game business, how much did NQ pay? How about $51M, or 5x 2013 net income? $51M is NQ's stock price at the time of acquisition in Nov ($6.4) times 6.2M ADS paid (including earnouts) for 78%.

Feiliu's founder is a good friend of NQ's founder. After all, NQ owned part of Feiliu for a long time. And the two companies were exposed by CCTV together in its 3.15 consumer rights report. And maybe Feiliu's founder believe that NQ's stock can easily be a 3 bagger. But that will still imply a 2013 P/E of 15x for the acquisition price, for a company whose revenue will nearly be 3-4x of 2012 in 2013, supposedly with high margin (like NQ) and actual cash flow (unlike NQ). Can Feiliu's founder be so generous?

A mobile game studio founder in China (funded by a top 3 silicon valley VC firm) observed that Feiliu is not a top 5 iOS game platform in China. That's just one input and it's qualitative, but it's from someone who is obsessed with marketing ROI for his games. Also, note that >50% of iPhones in China are jailbroken and get their apps from stores not owned by Apple while Feiliu depends heavily on Apple store for traffic. These qualitative observations don't mean Feiliu cannot grow 3x its revenue in 2013. But I will come back with more quantitative comments when I get those.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.