If you follow growth stocks, small-cap stocks, China stocks, or some combination of the three (small-cap China growth, anyone?), chances are you noticed that VisionChina Media is down some 50% in about two months.
When a stock drops that much, it gets my attention. That's because dumpster-diving can be a very profitable activity. So what's the outlook for VisionChina Media? And is it a buy?
Meet our contestant
VisionChina's business, in which it distributes television content and advertising to buses and subways in China, was appealing to investors for a number of reasons.
First, it was fast-growing. Sales were up more than 250% in 2008 and more than 70% through the first half of 2009. Second, it was light on capital, with operating expenditures checking in at less than 20% of sales in 2008. Third, it had a strong balance sheet with more than $100 million in net cash. Finally, it was wildly profitable, with better than 60% gross and 40% operating margins in 2008.
All of this propelled the stock up to more than $20 per share. Then, however, the advertising market in China began to weaken and Vision's results began to suffer. The stock was trading for over $8 at the beginning of March and closed yesterday at less than $5.
As advertising rates drop in China, Vision's sales are slowing and profit margins are narrowing. In fact, sales were up just 3% in the fourth quarter and the company's gross margin dropped to 45%.
This problem was compounded by the company's decision to purchase DMG Media, the operator of digital mobile TVs in the Shanghai subway system, for $160 million in cash and stock. That move dramatically increased the company's fixed costs and weakened its balance sheet, at a time (the present) when it doesn't look prudent to have done either of those things.
All of this resulted in the company issuing first-quarter 2010 guidance of "no less than $22 million" in sales. Analysts suggest that portends a significant net loss. Put it all together, and VisionChina is no longer fast-growing, no longer has a strong balance sheet, and is no longer wildly profitable. So you can understand why the market has soured on the stock.
So is it a buy?
My problem with VisionChina's guidance is that by my estimate, it implies a near 50% drop in the rate the company charges advertisers. We all know advertising is a cyclical industry, but that's a pretty violent decline. It also stands out because industry peers Focus Media
That said, all of these companies are focusing their expansion on China's tier 2 and tier 3 markets, where consumers have less discretionary income and advertising rates presumably are lower. Thus, it's unclear where rates will settle out as the advertising environment rebounds in China, given the potential revenue-mix shifts. While VisionChina's networks in Beijing and Shanghai are premium assets that should command premium prices, revenue and margins will be down if growth largely takes place in tier 2 and smaller cities such as Harbin and Chengdu.
Yet the magnitude of that drag is difficult to know, and any valuation of VisionChina will vary widely depending on our ad rate assumption. If we believe in the Chinese consumer, and that Chinese companies and multinationals will try to build well-known nationwide brands in China, then we would forecast a brisk advertising recovery in all markets. By that logic, we should buy VisionChina stock at today's prices, even if we have to ride out a rough first quarter. If, however, we believe that it will take a much longer time to bridge the gap between China's rich and poor, then VisionChina's stock still doesn't quite look like a bargain.
There are no called strikes in investing
I'm holding off on VisionChina for now, and continuing to gather information. My thesis is that the best performing part of China this year will be rural China, and that tier 2 and tier 3 cities will continue to struggle, given all of their excess capacity in real estate. That would mean a rough ride for VisionChina, its ad rates, and its investors.
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This article was first published on March 26, 2010. It has been updated.