Pharcyde22 (< 20)

eLong – The Misunderstood Story (Part 1)

August 25, 2011 – Comments (0) | RELATED TICKERS: LONG , CTRP

eLong – The Misunderstood Story (Part 1)

Reading many of the message boards and posts regarding eLong, I realize the majority of retail investors have completely misunderstood this company and its valuation. I’m writing this blog for the purpose of educating them on the entire China online travel landscape and clarifying some of the confusion regarding this company-specific story. This is part one of a two part analysis.Part two will focus on competitive landscape, eLong's positioning, and macro scenarios.

Misconception # 1 - Valuation is astronomical

Over the last year and a half, very few public companies have gotten more hurt on currency fluctuations than eLong. The past twelve months alone, the renminbi increased 6% against the U.S. dollar. Although eLong has had a pristine balance sheet with $283 million in cash (as of June 30th) and no debt, management has made the mistake of not holding the majority of this cash in RMB. The foreign exchange losses due to RMB’s rise in 2010 alone accounted for ($US) .15 per ADS share, or an astounding 127% of eLong’s reported FY2010 diluted earnings (GAAP). This pattern continued into 2011 as Q1 and Q2 losses foreign exchange amounted to .08 per ADS share, or 100% of their reported diluted earnings per share. This one factor alone has been largely responsible for its high P/E ratio (ttm) of ~172x. Excluding foreign exchange losses decreases the P/E ratio (ttm) dramatically lower to 57x, and a FY2011 P/E of 45x. In Q2’s conference call, management stated they would allocate over 80% of their cash in RMB and the rest in $US from a prior distribution of 41% RMB and 59% $US. This will stop the large foreign exchange losses should the RMB continue to appreciate. If there is a reversal of currency trend, eLong will be at least more comparable to their domestic counterparts.

At about $8.09 per ADS share, eLong’s cash represents a material percentage of its total market capitalization: a whopping 44% to be exact. To compare with eLong’s closest rival, Ctrip’s cash to market cap is only 8.7% with $3.43 per ADS share. Since neither company has debt, it would be more accurate to exclude cash from the P/E ratio to compare true operational performance. So excluding cash and foreign exchange losses for both companies, eLong’s P/E (ttm) is 30x, and 23x for FY2011 vs. Ctrip’s 24x FY2011.

As we all know, P/E ratio alone means nothing. Valuation metrics are only useful in relative comparison, but adjustments usually must be made by analysts to accurately reflect a company's core operations vs. its competitors. The currency moves of late are clearly extraordinary in nature and not related to eLong’s core business. Also, their considerable cash pile should not penalize them, since they have no debt. eLong’s adjusted P/E of 23x seems like reasonable value considering they compete in the nascent, yet rapidly growing China online travel industry.  

Misconception # 2 – All Chinese ADRs are Frauds

I will just make a few brief, logical points as there is a plethora of information on this topic online.

The vast majority of these frauds are reverse mergers, structured in this fashion as a means to raise capital in U.S. public markets. Since Expedia took majority ownership of eLong (I believe in 2004), the company has always carried a large cash balance. They never needed to raise capital. Expedia has invested over $160 million into eLong, with 84% voting rights. Tencent has recently invested over $84 million. Expedia’s management has stated numerous times that eLong is their major vehicle to tap into China’s market, and that it is of the highest strategic importance for the company to successfully penetrate China. Simply put, Expedia has way too much to lose.

Finally, considering the amount of coverage “China ADR frauds” has gotten the past few years, one would think that eLong would have been mentioned by an analyst by now if it truly was suspicious. Ernst and Young, eLong’s auditors, earlier this year uncovered material issues in China Agritech’s (CAGC) financials. E&Y threatened to quit unless changes were made, but instead, CAGC dismissed E&Y as their auditors. E&Y would have done the same thing to eLong by now if there was material omission or fraud.

I believe eLong’s perception as “another shady small-cap China ADR” is an added source of the company’s relatively cheap valuation. Investors should see that Expedia’s ownership of 84% of high vote ordinary shares effectively means you’re buying a fractional share of Expedia that’s solely exposed to China’s growth in online travel booking.  

Disclosure: I own shares of eLong (LONG)