Keda @ 50 cts ( Video conferencing / China ) 6 comments
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2.No reason why it should have competitive edge in video conferencing systems over foreign rivals
3.Seasonality suggests big risks; better to watch out for 2H05 results
When I started this site I wondered how many articles I could write, since it appeared that there can only be so many stocks that are subject to excesses. However it appears I have underestimated the pipeline of stocks not to buy; they just keep coming all the time.
Keda is an anomaly in a sea of red; in a period where "red" stocks (ie. China stocks) are seeing "red", especially the recent IPOs, Keda has actually risen from its July 05 IPO price of 34 cents to its current price of 50 cents -- a near-50% increase. That ability to buck the trend is amazing in itself and is even more so when one learns that it is a SESDAQ stock with FY04 (IPO year) revenues of ~S$20M; this is the category where most IPOs, China-linked or otherwise, have collapsed without trace post-IPO in recent times (think Azeus, Daka, Armarda, ATM, Pan Asian, Sunpower).
What is the reason? I have pored over its IPO prospectus and sole post-IPO financial statement and don't really find any strong rationale for its outperformance. The company derives about two-thirds of its business from providing video-conferencing systems to local China customers, in particular government agencies and public utility companies. For the remaining one-third, the company has stated in their prospectus that competition is rife in the access net platform products and remote bridging products segment (total ~25% of revenue base) and revenue decline is expected. The company is optimistic on the video monitoring systems market (the trend for increasing security) but given that it occupies <10% of revenue presently (ie. S$2M!) where is the critical mass?
That leaves us with the main segment of video conferencing systems, as mentioned above. What is Keda's competitive strength in this segment? Surely there is no "local content" in video conferencing systems that serves as barriers to entry?(eg. the China search engines Baidu and auction site Alibaba have a distinct advantage over Western Internet companies because they have captive cultural content) What is there to stop much bigger competitors like Sony and Huawei (as listed in the prospectus) from cannibalising on its market and limiting profit margin and revenue growth (note that pre-tax profit margins are quite substantial at >30%)? Apparently Keda has a strong customer base of government agencies and public utility companies; I would like to draw attention to another recent China IPO, system integrator Sinobest which had a similar customer base (in fact its revenue base was quite substantial at >S$60M) but saw 1H05 profit drop by half year-on-year following its IPO.
A possible reason for Keda's strong price performance may be due to hopes of M&A (merger and acquisition) activity within the industry. As a recent Westcomb report pointed out, there are signs of consolidation within the industry as bigger competitors seek to expand via acquisitions in China. To quote an example:"in August 2005, Polycom announced its acquisition of DSTMedia Technology Company Ltd a privately held video solutions company headquartered in Beijing, China." In the absence of more information about the competitiveness of Keda's products, I decline to use hope as a strategy. This is especially so in the face of rather high valuations for a China IPO: 10 times trailing PE based on proforma earnings(I am usually sceptical of proforma; I prefer actual). The 1H05 results are not particularly indicative of likely full-year performance given high seasonality of the stock: in FY04 the profit was split 5% in 1H04 and 95% in 2H04. That kind of seasonality in earnings is a great risk to assume, in my view; especially in the IPO year. The 1H05 results, although showing ~30% profit growth, are insignificant in my eyes; the proof of the pudding is in its 2H05 results and in its ability to issue a good full-year dividend. Already, in the same Westcomb report, they have highlighted the possibility that Westcomb may have a key video conferencing contract delayed in 2H05, affecting revenues substantially.
(I must clarify two points: firstly that although cynicism should be the default attitude to adopt towards analyst reports, sometimes the legwork and facts that the analysts gather from management are helpful, like what was stated above; secondly, I had decided on Keda being a "not-to-buy" stock before the Westcomb report, but was pleasantly surprised when the stock didn't capitulate after the report came out, hence giving me a chance to still write about it).
(1) 2 Dec analyst report from Westcomb on Keda Communications