Tuesday, December 21, 2010

The Competitive Advantage of China MediaExpress

China MediaExpress (CCME) provides television advertising on highway buses in China. The company trades for $525 million, but has earned $92 million in the last four quarters. In addition, the company has $170 million of cash against no debt. This would be an attractive valuation even for a company in decline, but China MediaExpress is in fact growing, as year-over-year revenue and profit growth in its most recent quarter is up 100% and 200% respectively.

Of course, many Chinese companies have a bad name right now because of rampant fraud that has been uncovered with respect to a few of them. But this one has a bit more credibility than the rest. For one thing, its financials are audited by Deloitte, rather than a mom-and-pop accounting firm or one that has had a relatively large number of legal issues in the past. The company also has a number of sophisticated investors, including Starr Investments, which is headed by Hank Greenberg. The company's clients also include reputable names such as Coke, Pepsi and Toyota.

But while the company appears cheap as well as legitimate, there are still some troubling signs. First, the company has a history of diluting its shareholders. Its diluted weighted average shares have nearly doubled in just the last year, from 20 million to 38 million. Furthermore, another 1.5 million warrants were exercised two weeks ago, and another 1.5 million or so remain outstanding, with very low exercise prices ($1/share, while the current share price is $15/share).

The company also has convertible preferred stock outstanding that can be converted into another 3 million common shares. What's most puzzling is that when the company issued the preferred shares in return for $30 million, it already had about $80 million in the bank against no debt. And it still hasn't put that money to work, which has resulted in what appears to be completely needless dilution!

But perhaps the biggest risk to this company comes from the source of its competitive advantage: the government. Until 2012, the company has an agreement with "an entity affiliated with the Ministry of Transport of the People's Republic of China to be the sole strategic alliance partner in the establishment of a nationwide in-vehicle television system that displays copyrighted programs on buses traveling on highways in China."

This agreement appears to have been extremely lucrative for the company, as it generates returns on equity of around 100%! But what happens after 2012? Who knows! The operating circumstances could change dramatically, or maybe not at all. Investors are basically at the mercy of some government official(s).

Until then, this company appears likely to continue to generate returns. But without any agreements beyond 2012, whether shareholders will get back a return on their investment at this price is an open question.

Disclosure: None

5 comments:

Anonymous said...

couple of quick comments: The dilution is in the original deal for the SPAC that the CEO would get 7M shares in 2011 and 2010, he let a big company be bought for less because he got this deal. 2nd: Starr was given a good deal because as the CFO stated they needed to gain credibility, which as you point out is lacking in china space. this was the main reason, good or not.

Anonymous said...

This writer's contention that government intervention is the sole reason for CCME's

success, or accounts for its success is simply incorrect. What the government of China has been doing, however, is trying to consolidate smaller companies into larger entities to achieve efficiencies, reduce waste, and pollution (in the case of coal and steel etc.)

CCME had already been amazingly successful PRIOR to getting the nod from the China transport agency to essentially keep doing what they have been doing since 2003. After 2012 and beyond, CCME's moat will be so large that they will have a lock on this market, and be expanding into other markets of course.

CCME is already present on so many inter-city buses, giving a nice extra revenue source to the independent operators all over China, that changing over after 2012 would require any competitor who came in to destroy their own profit margin to try to take business away. In addition, the fragmentation of the industry and CCME's early mover status makes the idea of competition after 2012 more of a conference room hypothetical rather than a real threat. The only competitor who could attempt to do so at this point would be FMCN, and they are more likely to buy CCME outright that to try to compete with CCME's lock on the market. No, CCME's moat is too wide, and their ties to the gov't mesh with the gov't desire for consolidation, wholesome programming, and trusted and innovative leadership which leads to stability, employment, and tax revenues.

Millstone

Disclosure: I own shares of CCME and call options in CCME.

Anonymous said...

Saj, thank you for posting this analysis.

CS

Anonymous said...

Saj,

What do you feel about the MuddyWaters Sell rec? Have you read it?

Diclosure: No positions long or short CCME

Saj Karsan said...

Hi Anon,

I have, but I don't really know what to think. I'm not 100% convinced either way so I'm just staying away.

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