Newsletter June 2006

Who’s hot among the Chinese NASDAQ names?   Based on the enthusiastic feedback we received from several of our clients, we attempt to use the same methodology to give a unique analysis of the NASDAQ listed Chinese stock universe. What makes our analysis very relevant is that seventeen liquid Chinese NASDAQ names reported quarterly earnings in the month of May, 2006. To put these reports into perspective, let’s examine their five year revenue and revenue growth history, earnings and earnings growth history, and than let’s compare these measures to market reaction and expectations.  The following chart reveals that over the last five years, the highest revenue producers has been Shanda (SNDA), NetEase (NTES) and the web content specialist triumvirate, Sina Corp., Tom Online and Sohu.com. The “middle class” consists of CNTF, KONG, JOBS, FMCN, CTRP, HRAY and NCTY. Smaller players are BIDU, NINE, LONG and JRJC. Looking at the revenue growth chart above, the picture is not much different.  But this should come as no surprise given that all these companies started out from the same, very low basis five years ago. Looking at the earnings, an interesting picture develops. Our first observation is that it is NetEase (NTES), the internet advertising and online gaming provider and not Shanda, recorded the highest net income. Secondly, the revenue leader Shanda reported a 73 percent drop in earnings in 2005 and the trend continues into 2006. In contrast to the latest results, Shanda had been a long-time favorite by delivering strong earnings in the past. Thirdly, only TOM Online has delivered consistently increasing earnings among the web content triumvirate. TOMO essentially dethroned long-time favorites Sina Corp. and Sohu.com. Actually the earnings of two medium size companies, China TechFaith (CNTF) and Ninetowns Digital (NINE) exceeded that of Sohu.com in 2005. The only company from this stock universe that reported a net loss in 2005 is eLong Inc (LONG). The disappointing result of this online travel service provider is in sharp contrast to the other player in the same field, Ctrip.com (CTRP). Looking at the dynamics of the earnings growth, NetEase and Tom Online are the clear leaders followed by Sohu.com and Sina Corp. Baidu.com (BIDU), the search engine provider, distinguishes itself among smaller names with relatively robust growth, however the company is still young and needs more time to exploit its growth potential. With revenue and earnings figures in hand, let’s see what the market thinks of these results. First, let’s examine the price history of these stocks during these five years or within the last five years if the company happens to be younger. The following chart puts the price appreciation (Price vs. 5 yrs.) into perspective relative to actual earnings and revenue growth over this period. There is a general trend that higher earnings growth has been recognized and rewarded by the investor community. However there are some clear asymmetries. First of all, NetEase has been enjoying astronomical share price growth over the last five years. The stock price has multiplied more than 40 times! And the stock price keeps going higher still. Sohu.com and Sina Corp. also enjoyed exceptional price appreciation over the last five years. But remember, both SINA and SOHU enjoyed tremendous growth in the first two and a half years and have been underperforming since then.  See related chart on the bottom of the page. TOMO reported the highest revenue and earnings growth of the internet content provider triumvirate, however its performance is not clearly reflected in the stock price. This price asymmetry sheds light on the fact that “early birds”, e.g. Chinese internet stocks that have been around over five years, were vastly undervalued then. But when TOMO IPOd in March ‘04, the IPO price was measured up against the previous success stories of SINA and SOHU, thus leaving less room for easy gains. Still, TOMO looks undervalued in comparison to both SINA and SOHU. This fact is more obvious by looking at the revenue/earnings growth and current P/E chart below. TOMO is trading at around 23 times earnings vs. SINA’s 36 and SOHU’s 32. Ctrip.com, the online travel company, that became public about the same time as TOMO, is another stock that looks pricey. The Company is trading at 52 times earnings and looks overvalued relative to TOMO. But Ctrip.com is certainly a better bet than its competitor, eLong Inc. (LONG).  eLong has been reporting modest revenue growth with widening losses each year, underlying the fundamental difficulties online travel companies face in China. So from this perspective CTRP is operating phenomenally. Focus Media (FMCN) is another stock that has enjoyed considerable price appreciation since it IPOd almost a year ago. But the stock is a youngster with less than a year of market history and thus the comparison is not realistic. Comparing FMCN to China Tech Faith (CNTF) makes perfect sense since both companies IPOd about the same time a year ago. While revenue and earnings growth would suggest just the opposite results, CNTF has been trading basically flat while FMCN share price more then doubled.  The fact that both companies are trading at a comparable P/E ratio suggests that the IPO price of CNTF was set much higher leaving little room for price appreciation. 51job Inc. (JOBS) is the second most expensive stock by looking at trailing P/E. The Company reported mediocre top and bottom line growth yet enjoys relatively high share price. As we suggested in the April 2006 Newsletter, investors should exercise extreme caution with this stock. Based on revenue breakdown, the Company is deriving almost two thirds of its revenue from print advertisement, a segment that has limited growth potential, while online recruitment accounted for only 26 percent of 2005 revenues. And finally, let’s touch upon one of the most liquid NASDAQ listings, Baidu.com (BIDU). As the above chart suggests the stock is trading at an extremely high P/E ratio that does not seem to be justified by its revenue and earnings growth. But the company is relatively young and unproven and the hypothesis that Baidu.com will one day become the Google of China is still alive. Looking at quarterly earnings, the Company has pleasantly surprised the investor community by delivering better than expected results each quarter, continuing to push the stock price higher. To better understand what drives the NASDAQ listed Chinese ADR prices, next month we will undertake a study that will focus on primarily money flows and stock prices. We will study how much money it takes to move each stock one percent up or down and hopefully these two studies will fill in a gap that concerns most investors.      To access latest Newsletter and other research content, please register!