Tuesday, March 13, 2007

KongZhuo (KONG)

Though I am a bit pessimistic on the prospects of China internet stocks and WVAS short term, several are beginning to trade near their cash value, which is peaking my interest (similar to how internet stocks in 2002 traded below cash).

KONG is one of the leading WVAS providers in China. WVAS refers to "Wireless value added services", such as ring-tones, games, and other neat add-ons. In the markets nascent stage, carriers were content to allow 3rd party vendors to aggregate content and distribute it through their network, but as the WVAS market has grown, mobile operators are increasingly wanting more of the pie. KONG, LTON, and TOM (recently acquired), have all bit hit recently on fears that they are going to be cut out of the market.

Most WVAS providers act as middlemen between the mobile operators and content providers. Concerns are two-fold:
1) Mobile providers will charge higher license fees, or get into the business themselves and lock out the other players
2) Mobile operators will develop their own operating systems and use this to either charge fees to developers/WVAS providers, or to control what content is allowed on their network.

Both seem to be vaild concerns, but valuation levels are starting to become so low that the reward may outweigh the risk.

KONG trades at an EV of about $130M (market cap net cash), and reported earnings last year of about $22M, making the name trade at a P/E of about 6. Perhaps justified given the WVAS pressures, but it is beginning to become attractive.

What really has attracted to me to the name, however, is the management team. In addition to starting KONG (which, until recent pressure, was a hot business), this group has also held senior positions and Sohu.com, one of China's leading internet portals. It should be of no surprise then, that the company has focused on building out its wireless internet portal, which it believes will be the future crown jewel of the company.

I am a bit skeptical of the wireless internet portal story--essentially, they want to build a portal destination for people to access through their mobile phones, which may make sense in China, given high mobile browsing, which is much more common in the US. That said, I am concerned that advertising won't hit it big in the same way it has on the internet, as people on mobile phones typically are browsing more casually and for shorter durations, which is not condusive to any advertising other than branding (which accounts for a small portion of overall internet advertising). Anyhow, I do think highly of the management team, and trust them to have a better pulse on things than I do. I am looking to buy this at or closer to cash value as a speculative play with a strong margin of safety.


Ohad said...

I actually think the mobile internet initiative is brilliant. The closer the WVAS companies get towards the internet sector, the more independent and attractive they would become.

The high mobile penetration in china leaves no other choice for all the internet players in china so KONG might become an attractive takeover target for conventional internet stocks, since it will command a large market share of the huge cellular internet traffic.

It's nice to see how each WVAS provider is diversifying its business from the traditional model . The big question is will that traditional model will be viable in several years time. On the one hand, the mobile operators will forever the upper hand. On the other hand, the market is constantly growing and a new wave of revenue generating services would become available once 3g is launched this year. The big question is which trend will have the upper hand: regulations& fees or services growth.

Research Intensive Investing said...

Thanks for the comment, ohad. It is interesting to see the different ways in which each of the WVAS players are diversifying, and I do think the fact that each are going off in different directions speaks a degree to the opportunity (and uncertainty) in the market going forward. I do not know who will win out, but this seems like an attractive basket bet with valuations where they are.

Mobile advertising is still unproven, and I am hesitant that it will take off at it has on computers, due to several barriers (screen size, types of activities many use mobile phones for (not purhcasing, or if purchasing not of high $ products, etc.). Anyhow, this is a whole new frontier, and anything can happen.


Ohad said...

Hey Eric
3G deployments might be one of the possible catalysts for the 2nd half of 2007.
During the last year there was a drift towards 2G services, where both entry barriers and margins are pretty low.

Lightreading reported that a 3g tender is already out by China mobile for TDS-CDMA. That implies deployments should come by the end of 2007. both KONG and HRAY have been conducting trials with them with 3g services which will likely be more music and video oriented.

what's your take on the timing for building a position in either HRAY or Kong? looks like business would bottom in Q1-Q2 and from there a steady increase until China Mobile issues another round of regulations...

Research Intensive Investing said...

I took very small positions in LTON and HRAY for now. I think LTON has a good margin of safety since its pretty much at cash right now, though I could see another 15-20% downside as they burn through cash. For HRAY and KONG, it seems like a value at about cash is likely downside, which I could see them trading at depending on how nasty the new and future regulations are. I've held off on KONG since it still has a couple bucks to fall before being at cash value (I'd rather pay ~$30M net cash for HRAY than ~$150M for KONG). With HRAY, I think its trading close enough to cash that I feel comfortable with it here. Overall, I've built up a 1/3rd position in HRAY, and am looking to add more below 5 or at current levels once I get a better sense of the business going forward.

What are your thoughts?


Ohad said...

I am planning on buying the first portion of HRAY around the current price level dur to its great cash position and their relative resistance to china mobile pressure and regulations.

I agree with u regarding KONG. the stock has another 10-20% to drop until it reaches the bottom, mostly due to the investment in the mobile internet initiative.

About LTON, are yo sure your are not mixing book value and cash& equiv? according to what i see, they have "only" 61% of their market cap in cash. they are also the only WVAS that will most likely burn cash the coming 2 Qs. their buyback plan is a good sign, however.