Tuesday, March 15, 2005

Small-Cap Growth on the Cheap: China Finance Online (JRJC)

Looking for a company that can grow earnings at 30% annually for the next few years and trades at a current P/E of less than 15? Consider a small-cap stock called China Finance Online (ticker for ADS shares: JRJC, derived from "jin rong jie," meaning "financial industry" in Chinese), which provides financial market information and data to investors in China through an online subscription-based service. The company is a leader (possibly THE leader?) in this financial services niche, with aspirations of becoming the "Bloomberg of China."

To summarize the financial profile of the company:

Market Capitalization: $134 mil.
Price Per Share: $6.70 (close 14-Mar-2005)
Debt: None

Cash: $71 mil.
Cash Per Share: $3.55

Enterprise Value: $63 mil.
EV/Shave: $3.15

Year: 2001, 2002, 2003, 2004, [2005 (est.)], [2006 (est.)]
(Figures in $ millions)
Revenue: $0.1, $1.1, $2.4, $6.1, [$14.3], [$27.5]
Net Income: -$0.6, $0.2, $0.8, $4.6, [$9.2], [$18.0]

EPS: -$0.18, $0.01, $0.06, $0.26, [$0.46], [$0.90]

(Analysts' consensus estimates in square brackets)

5-Year Consensus Annual Earnings Growth Estimate: 28.8%

P/E: 25.8 (trailing 12 mos.), 14.6 (current 2005), 7.4 (forward 2006)
PEG: 0.51 (current 2005), 0.26 (forward 2006)
EV/Earnings: 12.1 (trailing 12 mos.), 6.8 (current 2005), 3.5 (forward 2006)

These valuation ratios are incredible! Where else is such phenomenal growth available for so low a price?

Here's the story on the stock: Since its IPO in October 2004 at $13 per (ADS) share, China Finance Online has traded as high as $15.99 and as low as $6.11, and is now hovering at the low end of this trading range. After reporting stellar revenue and earnings growth for 2004Q3 and 2004Q4, management warned in early February that reduced trading volume (January's figure was only 28% of trading volume a year ago in Jan-2004) in the weak Chinese stock market will have a negative impact on the company's business in 2005. Despite (or maybe because of) the seemingly frivolous nature of the warning (i.e., nothing really so new--the Chinese stock market has been weak for years!), investors reacted to the "news" negatively. Will analysts need to lower their revenue and earnings estimates for 2005 and 2006? Wall St. hates uncertainty, and the company's policy of not providing guidance has not helped either.

One worry investors have concerns growth in subscriber numbers. A look at subscriber data provided in the two earnings releases following the IPO shows:

Period: 2003Q3, 2003Q4; 2004Q3, 2004Q4

New Subscribers (thous.): 4.2, 3.3; 4.1, 4.0
Repeat Subscribers (thous.): 2.4, 2.0; 2.4, 3.1

(ASF = Average Subscriber Fee in $ for 3 months of service)
ASF Per New Sub.: $98, $139; $219, $285
ASF Per Repeat Sub.: $99, $127; $268, $297

Over the past two years, the number of subscribers has not risen very rapidly. Instead, revenue growth has been driven by doubling or tripling of subscriber fees, as the company has migrated repeat users to more expensive service packages.

On a more positive note:

1. Number of Subscribers: Despite the decline in price and trading volume in the Chinese stock market over the past few years, China Finance Online has managed to launch and grow its business. In my opinion, this indicates that the company has at least succeeded in identifying a pocket of demand--even in a bear market;

2. Average Subscriber Fees (ASF): ASF has risen dramatically, as the company has found customers for its more expensive, high-end services. A recently announced initiative targeting institutional users with a service costing $5,000 per year could support and boost revenues further;

3. Chinese Stock Market: When stock prices and trading volumes rebound (a bottom might have been reached on Feb. 1 when the Shanghai Composite touched its 6-year low of 1189; today it sits at 1284), the company's subscriber numbers could rise dramatically as more investors become active in the market.

In my opinion, China Finance Online looks very attractive at today's price. Absent accounting fraud or some unforeseen competitor entering the market and squashing its high profit margins, the company has excellent growth prospects over the years ahead. If the company does, in fact, eventually succeed in becoming the Bloomberg of China, or alternatively get bought out by a larger online company or financial institution, investors with a long-term mindset who are able to stomach short-term volatility will realize superb returns.

As a general rule, I do not buy stocks until the one-year anniversary (180-day lock-up on insider sales plus additional six months of "seasoning") following their IPOs, since I like to wait for better transparency, which only comes from "exposure" of the company through conference calls and earnings reports, and the "debate" investors go through in their daily trading of the stock. In this particular case, however, with the shares looking like such a bargain, I am considering taking a partial long position if all continues to check out through the first quarter 2005 earnings release in April or May. Over the next month or two, I will be looking for confirmation in three areas:

1. Sustainability of subscriber growth: Are subscriber numbers still growing rapidly?
2. Institutional demand: Will institutions buy the high-end services? (This is essential if the company is to become the Bloomberg of China.)
3. Competitive landscape: Is China Finance Online THE market leader? (How about homeway.com.cn?)

7 Comments:

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