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September 24, 2009 – Comments (2) | RELATED TICKERS: CNTF

CAPS Contest Idea: Short China Techfaith Wireless (CNTF)

It’s Thursday AM and that means it’s time for this week’s CAPS Champion of the World Contest idea.  All you need to do to qualify for a prize is rate one of our official ideas thumbs up or thumbs down each quarter, and this is one of those ideas.  So, if you’re not signed up get going!  If you’re looking for a quick rundown all the rules, you can find those here.  

This idea comes from Global Gains co-advisor Nathan Parmelee.

Short China Techfaith Wireless (CNTF)Thesis

Chinese equities have been on a tear and China Techfaith Wireless has enjoyed the rally too. But China Techfaith Wireless is in the hyper-competitive market of mobile phone design and manufacturing, and despite growing revenues by more than 30% a year over the last five years it hasn’t earned a single dollar of cash. This cash eating machine now trades for $50 million more than its cash balance and approximately at tangible book value after taking into account a recent capital raise on unfavorable terms. I think both cash and book value will decline in the future, which makes this a great short idea at current prices.

Company description

China Techfaith designs mobile phones, develops wireless software, services, and games, and makes and sells phone handsets. The first two businesses are primarily services that I believe earn healthy margins and are where China Techfaith should focus its efforts. But 90% of China Techfaith’s revenues come from handset sales and it is handsets that have driven the dramatic revenue growth of the last few years.

Valuation

China Techfaith trades at 4.5x EV/EBITDA, 21x earnings, has $111.8 million in cash, and little debt. Normally those are reasonable multiples, but the multiples and the cash balance aren’t useful yardsticks in this case, because China Techfaith has never turned in positive free cash flow and has been consuming cash for years. The current cash balance would actually be $30 million lower if the company hadn’t recently sold debt, equity, and warrants in its online video and gaming unit to bolster its coffers.

But to really understand China Techfaith’s valuation all you have to do is look at its deal to purchase the smartphone brand QiGi. China Techfaith is paying $12.5 million for QiGi, a small amount in relation to its cash balance, but the company is only paying $0.5 million of that price in cash. The rest it is paying in its shares. If it felt its shares were cheap it wouldn’t be so willing to part with $12 million worth of them. Similarly I don’t believe the company would have raised debt and equity recently if it saw positive cash flow around the corner. China Techfaith should trade for its cash balance and no more, because the cash balance is likely to gradually decline over time.

You can only short stocks with market caps above $150 million in CAPS and right now China Techfaith just sneaks by at $163 million. Short this stock while you can.

2 Comments – Post Your Own

#1) On October 07, 2009 at 1:23 AM, wirelesstechchen (< 20) wrote:

Let's look your analysis. You recommended to short CNTF based on the following points:

1. CNTF went up a lot and out perform the China market.

CNTF out perform China market. This is true, but one needs to remember CNTF was traded under cash value and CNTF was from loss money one year ago to have profit for almost one year now. The company is getting better and the stock price going up is a natual reaction to the improvement of CNTF business. The stock still trades under book value. From valuation point of view, CNTF is still under value.


2. CNTF does not generate cash flow and loss money.

Obviously, you did not compare their balance sheet one year ago and now. CNTF had almost one year profit and the company makes money and cash position increases from one year ago (The net cash position(after take away $19M invested from the two VCs) is higher than one year ).


3. CNTF made a bad deal to get cash from VC because CNTF need cash.

CNTF is trying to diversify its investment, not just soly in cell phone business. Any investors would agree on that and like to see that. CNTF made the deal with the VC for $20 million cash is to reduce the risk for the game business also. Remember, CNTF has only made $10M investment in the gaming business before the VC investment, but the gaming business of CNTF was valued at $50M when VC made the investment. I don't see this as a bad deal.

4. CNTF bought QIGI using stock, not using cash because CNTF not able to generate cash in future.

CNTF made a very good on QIGI condition. Yes, it uses the stock, not cash for the deal. Because CNTF wants QIGI to share the profit and risk together. If QIGI makes good 2009 and 2010 goals, CNTF stock will go up and QIGI's initial deal of $12.5M will worth more than that. I see the management did great here: reward good deed and punish non performers.

All your points are invalid. Are you sure your recommendation? "Short this stock while you can". If you are so sure, I would challenge you to put money and short the stock. Let's where the price will be at the end of 2009. I am long CNTF.

The recent profit taken on CNTF is really normal. It will gradually go up soon. If you look at the historical trading pattern, you know what I mean.

All technical indicators also show CNTF is very bullish.  The link for the technical analysis for CNTF:

http://www.stockta.com/cgi-bin/analysis.pl?symb=CNTF&num1=603&cobrand=&mode=stock

Please do more research before make any foolish recommendation.

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#2) On October 27, 2009 at 6:22 AM, Rightfull (< 20) wrote:

perhaps ist a bit late for this comment , but still as time moves on it's interesting how things evolve.

 I'm having this stock now for 4 years as a small position in my basket.This position was beaten down so hard that i thought, what the heck, just keep it. Let's see if they can cope the challenges coming up .

The Big Challenge was to turn their mobile phone business to 3G while keeping down their cash burn rate. And what to say, they really worked hard on it, cut their work force and concentrated on their goal. And finally, at the beginning of this year it's clear that they reached their goal despite the challenging environment. Even more it shows that Management really tries to go a step further, with gaming handhelds (motion sensor), entering the online game market with VC's on Board, creating a Branding company (Dmagicmobile) and buying QiGi it shows, that they build up a strong vertical Lineup from Production of Hardware to selling Brands for special Interest Groups. This vertical lineup will generate more stable profits and a mesh of partners and distributors. Surely they are on the right track and have a vision to make techfaith a very profitable company. As a young company they managed a difficult 2 year Transition, flexible enough to cope very challenging situations. And this experience is great to the extent that they know how important it is to keep up a healthy Balance, react fast and take the right decisions while diversifiying the risks.

As i'm a long term investor i build up position (ten times the original size since january) and still will increase position as good entries are provided.
As to your recommendation. Surely you can short sell on extrem situations, but nevertheless it's a versus the trendline and thus a quite risky recommendation. cntf will keep on prospering. They are in a great shape compared to the years before.


Actual Market Value: $ 135,641,680 ($3.13)
I could imagine that they will double or tripple this the next 2 years. But lets see how it works out. I will strengthen this position a bit more until Monday, November 23, 2009. Than we know more.

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