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Short China Techfaith Wireless?

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By TMFMmbop
September 25, 2009

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RELATED TICKERS: CNTF

CAPS Contest Idea: Short China Techfaith Wireless (CNTF)

It's Thursday AM and that means it's time for this week's CAPS Champion of the World Contest idea.  All you need to do to qualify for a prize is rate one of our official ideas thumbs up or thumbs down each quarter, and this is one of those ideas.  So, if you're not signed up get going!� If you're looking for a quick rundown all the rules, you can find those here.  

This idea comes from Global Gains co-advisor Nathan Parmelee.

Short China Techfaith Wireless (CNTF)Thesis

Chinese equities have been on a tear and China Techfaith Wireless has enjoyed the rally too. But China Techfaith Wireless is in the hyper-competitive market of mobile phone design and manufacturing, and despite growing revenues by more than 30% a year over the last five years it hasn't earned a single dollar of cash. This cash eating machine now trades for $50 million more than its cash balance and approximately at tangible book value after taking into account a recent capital raise on unfavorable terms. I think both cash and book value will decline in the future, which makes this a great short idea at current prices.

Company description

China Techfaith designs mobile phones, develops wireless software, services, and games, and makes and sells phone handsets. The first two businesses are primarily services that I believe earn healthy margins and are where China Techfaith should focus its efforts. But 90% of China Techfaith's revenues come from handset sales and it is handsets that have driven the dramatic revenue growth of the last few years.

Valuation

China Techfaith trades at 4.5x EV/EBITDA, 21x earnings, has $111.8 million in cash, and little debt. Normally those are reasonable multiples, but the multiples and the cash balance aren't useful yardsticks in this case, because China Techfaith has never turned in positive free cash flow and has been consuming cash for years. The current cash balance would actually be $30 million lower if the company hadn't recently sold debt, equity, and warrants in its online video and gaming unit to bolster its coffers.

But to really understand China Techfaith's valuation all you have to do is look at its deal to purchase the smartphone brand QiGi. China Techfaith is paying $12.5 million for QiGi, a small amount in relation to its cash balance, but the company is only paying $0.5 million of that price in cash. The rest it is paying in its shares. If it felt its shares were cheap it wouldn't be so willing to part with $12 million worth of them. Similarly I don't believe the company would have raised debt and equity recently if it saw positive cash flow around the corner. China Techfaith should trade for its cash balance and no more, because the cash balance is likely to gradually decline over time.

You can only short stocks with market caps above $150 million in CAPS and right now China Techfaith just sneaks by at $163 million. Short this stock while you can.