Napoleon once said "Let China sleep, for when she awakes she will shake the world," and boy, was he right. Unless you've been auditioning for the role of Rip Van Winkle over the past two decades, it's been hard to miss the stunning emergence of China -- and its 1.3 billion people -- onto the stage of the world economy.
Much attention has been focused on domestic plays that bet on the strength of Chinese demand for basic commodities -- PetroChina
There are literally hundreds of WVAS providers in China, and while these companies all stand to benefit from a trifecta of revenue drivers -- the dynamic growth of the Chinese economy in general, the continued rapid adoption of cell phones, and the inherent growth of the WVAS market itself -- my favorite pure play in this space is KongZhong
Let's take a closer look, shall we?
According to the Organisation of Economic Co-operation and Development, China posted average growth of roughly 9.5% over the past 20 years and boasted the world's sixth largest economy at the end of 2004, with a GDP of nearly $2 trillion. While this pales in comparison with the $11.7 trillion U.S. economy, China's rapid growth has economists projecting that China could become the world's largest economy by as soon as 2035.
Two areas that illustrate both China's coming-of-age and the untapped potential remaining in the economy are the country's rapidly growing wireless market -- and the wireless Internet sector.
The Chinese wireless market
From a mere 52 million cell-phone users at the end of 2000, China now has close to 400 million wireless subscribers -- the largest market in the world, well ahead of the 202 million phone users in the U.S. Heck, China Mobile
Pretty impressive, isn't it? Well, yes, but not as striking (or daunting) as the fact that China's 400 million cellular customers represent a penetration rate of only 30%, compared with the roughly 70% rate of the U.S., and the more than 90% penetration rate of Western Europe.
Chinese WVAS market
As I previously alluded to, WVAS providers offer commercial services -- games, customized ringtones, music downloads, the ability to send emails and video clips, and so on -- via cell phones. According to Norson Telecom Consulting, revenue generated by WVAS providers (not including the big telecoms themselves) in China will grow from the estimated $565 million in 2003 to more than $1.9 billion in 2008, a compound annual growth rate in excess of 27%.
These estimates are likely to prove conservative for one main reason: Growing per capita income in China. In upwardly mobile China -- where, according to Professor Zhou Xiaohong of Najing University, 40% of the population will be "middle-class" by 2025 -- these phones/services are signs of prosperity and are eagerly embraced by those that can afford them, and KongZhong should be a prime beneficiary.
Crunching KongZhong's numbers
In the quarter ended Dec. 31, 2005, KongZhong derived 67% of total revenue from 2.5 generation services such as Java-based games, multimedia messaging, and WAP (wireless application protocol) services, down from the 90% recorded in last year's quarter (more about that later), but well ahead of some of its competitors.
The reason I highlight the importance of KongZhong's leading position in 2.5 generation services is that there are a number of near-term catalysts that should drive increased adoption among cell-phone users, such as new offerings of 2.5G and 3G handsets (the company is working with mobile phone manufacturers on embedded WVAS), and the roll-out of MP3 downloading services. Furthermore, China Mobile's upgrading of its data centers -- to allow more mobile game players to play at once (KongZhong is the leader in mobile games) -- and its gradual roll-out of 2.5 generation offerings to its 180 million strong pre-paid user base, should also prove beneficial to KongZhong's bottom line.
The Chinese government is planning to issue its first 3G licenses to mobile operators later this year, and KongZhong's familiarity with advanced-generation services should give it an advantage in this space as well.
As I mentioned above, KongZhong's 2.5G services fell as a percentage of revenue, from 90% to 67%, but that was simply because the company has also focused on building its 2G products to ensure a diversified revenue mix -- a strategy that seems to be paying off as 2G revenue grew rapidly last year.
It's also comforting to note that despite ramping up brand spending (smart move for the long haul in the fragmented marketplace) and increasing payments to handset manufacturers for embedded WVAS, KongZhong still retains higher operating margins than many of its rivals. On a different note, the company also boasts a return on equity of 20%, better than the average 17% of its competitors.
All things considered, I believe that KongZhong is well positioned to take advantage of its leadership position in the WVAS market in coming years. Investors should be intrigued, especially once they get a gander at its attractive valuation.
The company currently trades at around 13 times expected 2007 earnings estimates of $0.96 per share (a 28% discount to its projected growth rate), while boasting a cash pile of approximately $117 million, or $3.27 per share. Backing out the cash, you're left with an industry leader -- in a fast-growing sector, in the largest market in the world -- that trades at nine times earnings and at a 50% discount to its growth rate. I'd say investors with an above-average risk tolerance will want to take a closer look at KongZhong.
Fool contributor Will Frankenhoff enjoys writing for the Fool even more than he enjoys playing golf. He welcomes your feedback. He does not own shares in any of the companies mentioned above. The Fool has a disclosure policy.