You'd have a hard time finding a company growing moderately fast that's trading more cheaply than Chinese auto-sales facilitator Bitauto Holdings (BITA). The company reported earnings on Tuesday that showed it was gaining market share in some of its most important niches. And it's backed in part by three Chinese giants: Baidu, Tencent Holdings, and JD.com.
Over the past year, non-GAAP (generally accepted accounting principles) earnings jumped 65% on a 31% increase in revenue. Yet the stock trades for a measly 13 times trailing earnings.
But that doesn't necessarily mean the stock is destined for greatness. After running the numbers over a year ago, I was convinced this Chinese small cap was trading in an extreme value range. Since then, shares have lost half of their value.
What's going on here?
Image source: Getty Images.
The basics of Bitauto's business
Before diving into the weeds, it's worth outlining what, exactly, Bitauto does. The company has three lines of business:
- Advertising and subscriptions: Chinese auto dealers can buy ad space, and sign up for subscription services that allow lead generation for car sales.
- Digital marketing: Automakers can design marketing projects.
- Transaction services: Car buyers can find financing to purchase their cars.
Of these three, advertising and subscriptions has historically been the stalwart part of the business, while digital marketing has always been relatively small. Transaction services, on the other hand, is the real growth engine.
Check out the latest earnings call transcript for Bitauto Holdings.
Chart by author. Data source: Bitauto investor relations. Figures converted to U.S. dollars at 1 yuan = $0.1455.
This is where things get a bit complicated. Bitauto, realizing that it needed more resources to capture the enormous market for financing autos, created a subsidiary called Yixin. Yixin is a publicly listed entity in Hong Kong -- and it was created with investments from JD, Tencent, Baidu, Bitauto, and public investors. Currently, Bitauto owns 44% of Yixin, and almost all transaction revenue recognized by Bitauto comes from Yixin.
Still with me? Good, because there's one more part to cover.
There are two ways Yixin gets customers the financing they need -- either by providing the financing itself, or by facilitating financing on its platform with third parties (Chinese lenders, insurance providers, and aftermarket specialists) offering up their services.
For most of its history, Yixin provided the financing itself. This wasn't desirable for two reasons. First, it took on the risk of loans defaulting. Second, it didn't have much of a moat around it.
By providing the platform that connects insurance agents, banks, and car buyers, however, both of these problems are solved: The loans are on the bank's books, and Yixin gets to benefit from network effects.
What's happened over the past year should have investors very happy:
Data sources: Filings with the Securities and Exchange Commission; quarterly conference calls. Chart by author.
This is phenomenally fast progress. In less than a year, the percentage of loans originated using the platform grew from 8% to 60%. On an absolute basis, such loans grew almost tenfold in three quarters.
This is important and enormous progress, though that progress doesn't seem to be inspiring much confidence on Wall Street. With Bitauto's investment in Yixin valued at $830 million (taking 44% of Yixin's market capitalization on the Hong Kong exchange), today's market cap for Bitauto values the advertising, subscription, and digital marketing businesses at just over $400 million.
To put that in perspective, that $400 million is far less than sales of $757 million for the non-transaction-related businesses. And the company's net cash position (cash and investments minus long-term debt) is positive as well -- currently at about $350 million. In essence, buying shares now gets you Yixin at cost, and everything else is almost free.
What's going on here?
In my earlier days as an investor, I would "back up the truck" and buy lots of shares of a company. Time has taught me that's not always the best choice.
Clearly, investors are bearish on Bitauto's prospects: Approximately half of all shares of the company are sold short. Another way to put it is that a lot of people on Wall Street are betting on the stock falling.
There are lots of reasons for this:
- The market for new cars in China has been getting weaker over the past year.
- Well-heeled competition exists in China from Autohome -- a company valued at over eight times the size of Bitauto. It should be noted that Autohome's focus is on lead generation, while Bitauto is increasingly about transactions.
- The company has had sizable equity awards over the past year. Some may interpret this to mean that management is paying both itself and employees more than they deserve.
But perhaps the two biggest hurdles are these:
- Bitauto is a small-cap Chinese stock -- and Chinese small caps don't have a great reputation in the U.S.
- Automated driving technology is coming, and no one knows how this will change auto-buying behavior in the coming decade.
I think both of those concerns are very real. So while I'm happy as a shareholder to see Bitauto gaining massive market share in auto transactions, I'm not in any hurry to increase my position beyond its current 1% allocation in my portfolio.
