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MagicDiligence (< 20)

Magic Formula Stock Review: Qiao Xing Mobile (QXM)



April 24, 2009 – Comments (2) | RELATED TICKERS: QXMCF.DL , NOK , AAPL

Qiao Xing Mobile (QXM) is a holding company which conducts it's business through CEC Telecom, or CECT, an operating unit located inside the People's Republic of China (PRC). The company is one of the largest domestic makers of cell phones in China, where effectively all revenues originate from. The company sells under two brands: "CECT" is the legacy and low-end brand, while "VEVA" is a high end, smartphone-like brand launched last May. The majority of units are sourced through third party manufacturers, although a fair number (15% in 2007) were self-manufactured, and this figure should rise as QXM opened a new plant in January of last year. In all, Qiao Xing sold about 3.8 million handsets in 2007, the last full year of data.

Let's take a look at Qiao Xing using the 3 points of investment, and then detail some specific risks. First, the growth picture. I've given Qiao Xing a C+ for growth potential. The Chinese mobile phone market is one of the most attractive in the world for several reasons. First is a low penetration rate, which should rise given China's universal service mandates for telecom providers and the fact that those living in small cities and rural areas are benefiting from the country's emerging economy, giving them the chance to purchase items like cell phones for the first time. When you apply these factors over a population exceeding 1.3 billion people, it's clear that the mobile phone market there will grow at attractive rates for the foreseeable future. iSuppli estimates nearly 8% growth in 2009 to about 239 million units, a good growth rate with clear and substantially more growth possible (China Mobile (CHL) has over 600 million subscribers alone). This new adoption demand is also buttressed by replacement demand to higher end phones (as in most developed economies), taking advantage of emerging technologies like 3G data networks and touch screen phones. Qiao Xing's VEVA line is poised to benefit from this. Growth is tempered by competitive concerns, however, which will be detailed below.

The second point of investment is financial health. Qiao Xing looks in pretty good shape here, with 2.9 billion yuan in cash (about $425 million USD) to 1.2 billion yuan in debt ($175 million USD). Most of this is in short-term notes, not really the most desirable way to finance a business. Short-term rates are higher and the debt is due in the near-term... as a result Qiao Xing's interest coverage ratio is less than great at just 7x. This looks a bit risky given the volatility in the discretionary business of cell phones, but current ratio is comfortable at nearly 3. Return on capital is very good, at a normal rate in the mid-30%, and a Magic Formula rate of 51%. Free cash flow margin in 2007 was 27%, but likely lower in 2008. One thing that has been improving is operating margin, as the company focuses on higher end products - it has risen from 21% to 39% in just the last 4 reported quarters. The focus on VEVA is paying off here.

Last is competitive moat, and here we run into a big fat problem. Consider this: in 2007, Qiao Xing sold about 3.8 million units. By comparison, Nokia (NOK) sold about 71 million units. Other big cell phone makers like Motorola (MOT) and Samsung also have targeted China for growth. VEVA, Qiao Xing's future, faces established smartphone competition from Apple (AAPL) and RIM (RIMM), as well as Nokia. With such a small footprint and limited financial resources, it will be very difficult for Qiao Xing to maintain it's margins and grow at the same time given the competition and their scale advantages.

The biggest risk here is the short-term debt combined with a volatile market littered with bigger competitors. Like many small Chinese firms, Qiao Xing is tinged with the rumors of accounting inconsistencies. This is easy to understand when Q4 2008 results to this day have still not been reported, nearly 4 entire months after the end of the period. While the focus up-market with VEVA has so far paid off, I'm not sure how long it will continue, especially if Apple finally gets into China.

All of this said, MagicDiligence still is intrigued by Qiao Xing given it's nearly incomprehensibly cheap valuation. At $2.65 US per share, the market value is about 18.10 yuan/share, a market cap in yuan of 847 million. Yep, that's about 200 million yuan less than net cash on hand! Creating the enterprise value by subtracting excess cash and adding debt, the valuation is negative 668 yuan - MagicDiligence has never analyzed a stock with negative enterprise value before! In essence, the market is valuing Qiao Xing's ongoing operations at under 0. If the picture still isn't clear, the stock sells at under 1/3rd of tangible book value. In Ben Graham's world of cigar butts, it doesn't get any "butt-ier" than this! If you believe the company can survive amidst the competition, this is a no brainer. I won't recommend it for the MagicDiligence Top Buys list, but if price is your primary investment criteria, it doesn't get any cheaper than this.

Steve owns no position in any stocks discussed in this article.

2 Comments – Post Your Own

#1) On April 27, 2009 at 12:11 PM, glenn12345 (99.95) wrote:

1- The company runs highly successful informercial campaigns.  Look at their sales & advertising costs... they are rising.  Now those numbers may be fudged, but they will be using Zhang Ziyi (Crouching Tiger, Hidden Dragon) as their new spokesperson and this will definitely raise their costs and suggests that increased informercial spending is quite real.  You can tell what the most infomercial campaigns are by how many times they re-air it.

Not only are they making money, their earnings will likely grow in the future.

2- Nokia and company may be at a disadvantage in the Chinese market because the Chinese manufacturers violate trade dress and other IP.  There are a lot of knockoffs clones like the iphoMe... QXM/CECT makes their own iPhone clone.

3- Unfortunately, you will likely see very little shareholder value from this company.  XING (the parent) were sued over inflating he books of QXM when they IPOed it, and the company paid $2.1 million to settle the suit.  None of the insiders responsible for it paid anything.  On top of that, there are a huge string of dubious related party transactions that destroy shareholder value (e.g. insiders selling their own company to XING and causing extreme dilution to that stock; XING used to be the better buy than QXM because XING owns 70% of QXM).  This is what I call a money trap, so you have to be really careful and it's not as much of a bargain as you think.

The valuation is likely low because no institution is holding this (perhaps realizing that it's a money trap).  DKR does hold this but I believe they are an entity controlled by insiders.

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#2) On April 27, 2009 at 4:35 PM, MagicDiligence (< 20) wrote:

Really great info, thanks for all that.  CAPS is truly an awesome resource for investors.

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